Managerial Versus Contractual Approaches to Reform

The particular changes made via legislation and implementing actions will be discussed in subsequent chapters of this report. Here it is appropriate to conclude the discussion of the ideas that shaped New Zealand reform by analysing their overall impact on public management.

Sixty years ago, in launching the revolution in fiscal policy that bears his name, John Maynard Keynes wrote:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.

The New Zealand model confirms the power of ideas in transforming the State sector. But one should not lose sight of the fact that two sets of ideas vied for influence when the reforms were on the drawing board. The two converge in many aspects, but they have different roots and point in somewhat different directions. One is the managerial premise that those who are responsible for government programmes and organisations should be sufficiently empowered to act so that they can be accountable for their performance; the other is the contractual theory that government should be organised to minimise opportunism and transaction costs in relationships between self-interested parties.

The two ideas make common cause on some reforms but not on others. Whether one considers the operation of government from a managerial or contractual perspective, efficiency is gained by specifying objectives and measuring performance against them, as well as by freeing managers to use resources as they deem fit and then holding them accountable for what they have done. Both would argue for term chief executives rather than permanent department heads, for making chief executives rather than SSC the employing authority for civil servants, for appropriating on the basis of outputs rather than inputs and specifying expected outputs in advance, and for shifting from cash to accrual accounting and budgeting. The two approaches go their separate ways, however, in the emphasis placed on employment contracts, purchase and performance agreements, in the decoupling of policy advice from service delivery, the emphasis on ex ante specification, the sharp split between purchase and ownership and between outputs and outcomes, and the demanding accountability requirements.

Managerial concepts explain most of the innovations introduced in New Zealand, but not the most conspicuous ones. Arguably, the reforms inspired by a managerial perspective have brought most of the State sector improvement experienced over the past decade. This clearly is the view of the senior and middle officials interviewed for this report. In conversations, they overwhelmingly endorsed the view that the most important change was freeing managers to manage. Some suggested that upwards of 75 percent of the gain has ensued from this change alone.

The difference between managerial and contractual approaches parallels the contrast between "letting managers manage" and "making managers manage." The former assumes that once managers have been empowered, they will take initiatives that improve performance; the latter questions whether managers will be sufficiently tough-minded to make the needed changes unless they are prodded to act. Managerial reform is utterly dependent on the behaviour of managers, some of whom, contractual theory fears, will opportunistically prefer the ease of continuing the status quo to the difficulties of uprooting established practices and (if necessary) sacking sub-par performers.

Managerial innovation has a soft side which contractual arrangements seek to counter. The former assumes that managers want to do the right thing and will do so if given the chance; the latter assumes that managers are motivated by self-interest, which may take precedence over the organisation's interest. If one subscribes to the latter view, then the hard edge of contracts and other enforcing arrangements would be warranted. Yet if one were to reject the premise that managers habitually pursue the public interest, contractual remedies may nevertheless be inappropriate or insufficient. If managers were self-serving opportunists, it would be naïve to expect the proto-contracts and accountability reports introduced in the public sector would compel them to mend their ways. Even a contractual regime is dependent on the good behaviour of public managers.

There is much evidence of public - not just self-interested - behaviour in government. While it is common to refer to shirking and subversion by civil servants, hardly any mention is made of those whose normal workday is voluntarily extended beyond "9 to 5" and who faithfully carry out the instructions of superiors, even when they might prefer not to. The American political scientist John J. DiIulio, Jr. has written eloquently about "principled agents," public workers who "go above and beyond the call of duty, and make virtual gifts of their labour even when the rewards for behaving that way are highly uncertain at best" (DiIulio; Principled Agents: The Cultural Bases of Behaviour in a Federal Government Bureaucracy; Journal of Public Administration Research and Theory; Vol.4 July 1994; pg 277). Public-regarding behaviour is one of the main reasons why managerial discretion improves governmental performance. Without a strong public ethic, contractual remedies would be both necessary and inadequate.

Managerial versus contractual models are not just a battle over ideas. In New Zealand, they have strongly influenced practice as well. Contractual ideas account for (as mentioned earlier) some of the characteristic strengths and weaknesses of New Zealand reform. The strengths include the explicit specification of outputs, the chain of accountability running from Ministers through chief executives to civil servants, the search for increased contestability in public programmes, the fluid exchange of ideas and personnel between the private and public sectors, the strong (but perhaps not strong enough) emphasis on accountability, the challenging review of performance, and the insistence that performance be rated in terms of the personal responsibility of the manager, not merely as an attribute of the organisation.

Institutional economics and the array of ideas that have given rise to contractual theory provide powerful insights into the structure and operation of private and public organisations. They have spurred the infusion of modern business practices into the public sector and have also added muscle to accountability arrangements. They have enabled reformers to comprehend how structure retards or facilitates performance and to view public agencies as contracting - rather than merely as producing - entities. The concepts and techniques of contracting are likely to be in the toolkit of New Zealand public managers for many years.

But hard-edged contractualism also has shortcomings and costs. Four types of costs can be identified in the New Zealand model. The first are the high transaction costs associated with the various agreements and procedures required each year. These include the costs of negotiating the agreements and monitoring compliance, the costs of preparing periodic reports and statements, and the expenses of maintaining relatively large contracting and monitoring staffs. According to some managers, these costs have soaked up a substantial portion of the efficiency gains achieved by their organisation. Although these costs may be considerably lower than the deadweight costs of complying with central input controls, they are likely to be higher than those necessitated by managerial discretion. Yet transaction costs are not fixed; they can be mitigated by purging the various agreements of excess detail and by regarding them more as understandings than as firm contracts.

The second cost is more difficult to describe but may have a deeper impact. There is considerable risk that the contractual style of management may diminish public-regarding values and behaviour in government. If it is true (as is claimed) that the concept of a unified Public Service, with defined career paths, began to erode long before the reforms were introduced, then rather than interpreting this development as justification for further fragmenting the Public Service and erasing differences between public and private employment, one might argue that reform should seek to combat these trends. Many managers now see the Public Service as a way station between public and private jobs. If "in and out" career patterns seep down from the upper to middle and lower ranks, it may become harder to instill a public ethic among government managers.

The values of the Public Service include the trust that comes from serving others, the sense of obligation that overrides personal interest, the professional commitment to do one's best, the pride associated with working in an esteemed organisation, and the stake one acquires from making a career in the Public Service. To be sure, these values carry certain liabilities. They may discourage initiative and change; they may insulate the institution from outside pressure and from proper regard of those being served; they may lead to expedient incrementalism, in which tough decisions are avoided. But these side effects can be combatted by injecting a heavy dose of managerial values into the organisation.

The third cost is the weakening of collective interest. I believe that regard for collective values remains unusually robust and valued in New Zealand. Moreover in the period since this problem was considered by the Logan Review (Review of the State Sector Reforms) in 1991, notable strides have been made through mechanisms such as strategic and key result areas. Nevertheless, contractual arrangements may give politicians and managers a narrower view of their responsibility in the State sector than would be appropriate.

This parochialism arises out of the bilateralism of contractual relationships. Bilateral contracts - between Ministers and chief executive, between department and Minister, between the chief executive and senior managers, between Crown entities and the Ministers, and so on - are favoured because they are clearer, easier to enforce, and less prone to opportunism than multilateral arrangements. Yet, bilateralism does not embrace the whole of public responsibility; there always is a third party in public contracts. That third party may be the electorate, the government in its collective responsibility, the clients or beneficiaries of public programmes, or other interests. The third party is a stakeholder in the actions of the parties contracting bilaterally; its interest is not marginal. One is reminded of Edmund Burke's insistence that society is a contract "not only between those who are living but between those who are living, those who are dead and those who are yet to be born." Even more apt was Burke's challenge to the electors of Bristol (the borough that returned him to Parliament) that his obligation was to the public good as he saw it, not just to serve as their agent.

In bilateral relationships, it is hard for the third party to fit in. In the triangular relationship between the Minister, the chief executive, and SSC, the third party is often seen as an interloper, not as a legitimate participant in the negotiations.

The final set of costs relates to the practices implemented under reform, especially those that have encountered serious problems along the way. This writer does not regard it as happenstance that the Senior Executive Service (SES) provided for by the State Sector Act has not gotten off the ground; that despite expert and sincere effort, the specification of outcomes has not advanced; that despite its strong commitment to managerial discretion, New Zealand restricts transfer of funds between output classes, even those aimed at the same outcome, as well as between financial years; that identifying the government's ownership interest has been difficult. These problems and disappointments - and others - can be traced to the contractual model of reform.

(1) It may be that the SES failed because of apprehension that it would be deployed as a means of reinstating central constraints on the pay of senior officials. But it also is true that the SES did not comport with a two-party world in which chief executives employ senior officials under term contracts. If the new world of managerial accountability rests primarily on a contractual bond between chief executive and senior managers, then there is little scope for loyalty to the broader value of the Public Service supposed to be represented by the SES. (2) Outcomes are externalities in two-party relationships; therefore it is exceedingly difficult to assign responsibility for them. Outputs, by contrast, are internal and, hence, they can be covered in contractual bargains. (3) If output is contracted for at a fixed price (the amount appropriated), then it makes sense to restrict transfers between output classes--the draft legislation tabled in 1989 barred any such transfers but in formulating the Public Finance Act, Parliament permitted up to 5 percent to be shifted to other output classes. Similarly, the logic of contracting dictates that once agreed outputs have been produced, any unspent funds should be returned to the Treasury and not be spent on other output or saved for the next year. (4) Finally, "ownership" is the third party's - the government's - interest in the long-run capacity of the department to invest and innovate, not that of the party purchasing the output. The purchasing party may have little short-run incentive to invest in the capacity of the department (or other entity) to produce future output.

Bilateral contracting sharpens objectives and the terms under which they are to be pursued, provides more benchmarks for assessing performance and fewer escape routes for opportunism. In other words, the contractual model goes further than managerial reform in demanding accountability in the public sector. But, as argued, it exacts a substantial cost for achieving efficiency in output production. The ensuing chapters of this report discuss means of strengthening strategic and collective capacity, the allocation of resources, and monitoring accountability while softening the rigidities of management by contract.

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