The Relevance Of Commercialism to Government Agencies

Paper for “Corporate Governance in the Public Sector 2007 Conference”, Wednesday 19 February, Wellington. [1]

 

Keywords: Governance;

 

By the 1980s the traditional regulation of New Zealand’s private and public sectors had become increasingly obsolete. The story of the shift to ‘more-market’ and the privatisation of some of the public sector is well known. But a set of orthodox reforms were pushed to the extreme, the extremism failed, and in recent years much has had to be unwound. The public sector reform story is less well known.

 

The orthodox reform was was known as ‘public sector management theory’ which I shall describe shortly. Its essence was to allow the managers to manage. (I use the terminology of American public policy analyst Allen Schick, who wrote The Spirit of Reform: Managing the State Sector in a Time of Change, in 1996.) Following the liberalisation of management, the State Services Commission was not sure how to manage in the new environment.

 

Meanwhile, Treasury economists proposed a quite different approach based on New Institutional Economics, which argued the public sector should be regulated by business practices. Like other more enthusiastic elements of Rogernomics it was extremist, and there was little empirical evidence to underpin it. There were fewer public critics of this approach. As a result there has been less attention given to untangling and reversing the extremism.

 

I do not want to damn all commercialisation. However, some commercialisation successes do not mean that the policy will work everywhere. Ironically, but instructively, there will be few in today’s room working for a public sector agency for which commercialisation has been an unequivocal success. The reason you are most likely to be here is because it does not seem to be working properly in your agency.

 

This overhang from the commercialisation agenda is even inherent in the title of this conference ‘corporate governance’, a definition for which is

the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled, including the relationships among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.

 

This is a definition about businesses. We must respect the extraordinary success of corporations contributing to common welfare by providing certain sorts of goods and services. But that does not encompass the whole of the economic realm. It would be unwise to run one’s family according to best corporate practice. Nor is it obvious that the corporate form suits the public sector.

 

Why cant the public sector run like the corporate sector? The objective of a public sector agency is not as well articulated as is the ultimate objective of any corporation. In order to survive businesses have to make sufficient profits. Economic theory explains how – providing the market is competitive – such profit-driven sales can contribute to the social good. Within the public sector there is no single indicator as useful as profit to assess an agency’s performance. There are sub-indicators, but they are subject to Gilling’s law that the way the game is scored shapes the way the game is played.

 

Profit shapes the way commercial businesses play, but conveniently we want them to play that way, using their resources as efficiently as possible while meeting our market expressed demands. There is no such fortunate coincidence in the public sector.  As Goodhart’s lemma to Gilling’s law reminds us,  targeting on to a particular variable will usually change the relationship between the target and the goal.

 

How then to get a public agency to perform? Public sector management theory said ‘make the objectives of the agency as clear as possible and give the managers the responsibility for pursuing those objectives’, relying on their professionalism to do so.

 

An alternative approach is to operate the public agency like a business. While it would be foolish for the public sector not to learn from best business practice, the commercialist revolution of the 1980s was far more extensive, being based on contractualism. Business depends upon contracts in market transactions and (to a lesser extent) within the firm. When a product is sold or bought there is a contract between the purchaser and seller. Failure to deliver on the explicit or implicit contract is a matter of ‘accountability’ a term which is common in today’s public sector.

 

But suppose the product cannot be well specified especially where quality is important but difficult for the consumer to judge, while the transaction between the producer and consumer is infrequent – perhaps one-off – and there are few practical competitive suppliers. The producer might be a doctor making a diagnosis, a teacher undertaking a course, a scientist embarking on a research project, or a government adviser trying to set out the policy options to a minister. In each case the contractualist approach may not make a lot of sense because a contract cannot sufficiently specify what is the desired outcome. Gilling’s law threatens their professional competence.

 

Consider the first output class of the Treasury in 1995/6 when the commercialisation fashion was still strong. Its output statement was “Provision on the economy, including the government’s overall fiscal strategies and macroeconomic forecasting and monitoring.” Well yes. What the Minister actually relied on was not this promise of a pig-in-a-poke, but the professionalism of the Treasury, that the department and staff had a sense of public service to do the best to meet these objectives. That is as true for your doctor, teacher, scientist, or any other public servant. It is not so much the contract which drives them, but professional pride.

 

The following table contrasts the business sector approach (on the left) and the public sector approach (on the right).

 

SCHICK’S PUBLIC SECTOR MANAGEMENT DICHOTOMY

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NEW INSTITUTIONAL ECONOMICS

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PUBLIC SECTOR MANAGEMENT

\

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CONTRACTUALISM

\

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MANAGERIALISM

\

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People act in their own self-interest

 

\

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Managers cannot be held responsible for results unless they have the freedom to act

\

<>

Accountability

\

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Personal responsibility

\

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An impersonal quality dependent on contractual duties and informational flows

\

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A personal ethic, a commitment to do one’s best, a sense of public service.

\

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For-profit

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Not-for-profit

 

At the top line on the left is the business theory’s name ‘New Institutional Economics’, which leads to ‘contractualism’, based on the notion that ‘people act in their own self-interest’, so they must be made ‘accountable’, which is ‘an impersonal quality dependent on contractual duties and informational flows’. The bottom line reminds us that such organisation are frequently for-profit.

 

On the other side of the table ‘Public Sector Management Theory’ emphasises ‘managerialism’ with its notion that ‘managers cannot be held responsible for results unless they have the freedom to act’ which requires a ‘personal responsibility’, a ‘personal ethic, a commitment to do one’s best, a sense of public service’ and other not-for-profit organisations.

 

Now it might seem better to have both, but the two approaches involve fundamentally different ways of treating people. Contractualism does not trust people to act in other than their own interest. That is why they must be accountable through contracts which precisely specify how they must perform. Public managerialism trusts people to be personally responsible.

 

Schick was concerned with the tension between the two modes. The possibility is that contractualism (not trusting people) undermines public managerialism (trusting people). He said that contractualism ‘may diminish public-regarding values and behaviour in government’, including damaging such values as ‘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’. The accountability of contractualism may sabotage the responsibility of managerialism.

 

In his 1964 Modern Organisations Amitai Etzioni contrasts the ‘scientific management’ approach with the ‘human relations’ approach. Scientific management emphasises a pyramid of control topped by a single chief executive, with a need to provide mechanisms to ensure that those at lower levels do what is required. The expression ‘scientific’ is not particularly accurate, and sometimes the literature calls it ‘Taylorism’ or ‘the traditional approach to management’ .

 

ETIZONI’S MANAGEMENT DICHOTOMY

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Scientific Management

Taylorism

Traditional Approach to Management

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)

) Human Relations

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A. Etzioni (1964) Modern Organisations

 

The human relations approach was a reaction, arguing that effective work processes require a more decentralised management style, in which social norms and non-economic rewards are crucial, and collegial relations important.

 

About the same time, another organisational specialist. Douglas McGregor’s The Human Side of Enterprise, written used the more neutral terms of ‘Theory X’ and ‘Theory Y’, but they parallel Etzioni’s and the dichotomy I set out in the above table (which is based on Schick’s argument). Here is a tabulation of McGregor’s theory, although the two columns do not line up quite as nicely. (Note the New Institutional Economics in the last table aligns with Theory X in this one.)

 

McGREGOR’S MANAGEMENT DICHOTOMY

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THEORY X

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THEORY Y

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1. The average human being has an inherent dislike of work and will avoid it if he [sic] can.

2. Because of this human characteristic of dislike for work, most people must be coerced, controlled, directed, threatened with punishment to get them to put forth adequate effort toward the achievement of the organisational objectives.

3. The average human being prefers to be directed, wishes to avoid responsibility, has relatively little ambition, wants security above all.

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1. The expenditure of physical and mental effort in work is as natural as play or rest.

2 External control and threat of punishment are not the only means of bringing about effort towards organisational objectives. People will exercise self-direction and self-control in the service of objectives to which they are committed.

3. Commitment to objectives is a function of the rewards associated with their achievement.

4. The average human being learns, under proper conditions, not only to accept but seek responsibility.

5. The capacity to exercise a relatively high degree of imagination, ingenuity, and creativity in the solution of organizational problems is widely, not narrowly, distributed in the population.

6. Under the conditions of modern industrial life, the intellectual potentialities of the average human being are only partially utilized.

D. McGregor (1960) The Human Side of Enterprise p.33-34, 47-48.

 

Those familiar with Abraham Maslow’s hierarchy of needs will observe that Theory X focuses on the lower needs in the hierarchy and Theory Y the upper level ones. One of the weaknesses of economics and its related business theory is that it pays almost exclusive attention to the lowest of the Maslow needs – physiological and safety needs – and hardly recognises the higher ones.

 

MASLOW’S HIERARCHY OF NEEDS

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THEORY X VISION

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THEORY Y VISION

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safety needs

physiological needs

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need for cognitive understanding

need for self actualisation

esteem needs

needs for belonging and love

 

The notion of accountability which pervades current public sector governance is heavily influenced by Taylorism and Theory X. Contractualism requires the pyramid of control with coercive mechanisms to ensure that those at lower levels are committed to the achievement of their organisations’ objectives. By contrast, the human relations approach of Theory Y and public sector managerialism imply a decentralised management style, in which social norms and non-economic rewards are crucial, and collegial relations important..

 

Dichotomies are dangerous. I only put forward these differences to stimulate a discussion on public sector governance. Do we need such a debate? There seems to be a complacent acceptance of accountability and an underplaying of personal responsibility. The 2002 State Services Commission report, Review of the Centre, on how the core public service should be managed, uses the ‘accountability’ notion 36 times, but ‘responsibility’ gets only 14 mentions, and ‘professional’ a mere four. Have things improved since?

 

In those sectors with which I am familiar – health, research, science and technology, and tertiary education – there are still considerable tension between the managers of the organisations and the professionals – health workers, scientists and academics – who are at the sharp end of the organisation’s purpose.

 

By ‘managers’ I mean those involved in line management. They can be very professional, especially when they are working under a Theory Y approach. But they can be tyrannical under a Theory X approach. My ‘professionals’ exclude line managers, focusing on those who are required to apply advanced specialist knowledge in their work, utilizing their independent judgment and professional ethics to perform their tasks. Typically they operate under a collegially based Theory Y regime rather than a contractualist one, because it it so hard to define specifically what their precise output is.

 

Behind Public Sector Management Theory was the recognition of parallels between managers and professionals, with the aim of organisational structures when managers could behave like professionals. New Institutional Economics over-road this objective.

 

In core government departments the distinction between managers and professionals may be ambiguous. However elsewhere there is usually a clearer distinction, even when a professional becomes a manager – say a doctor becomes a superintendent of a hospital. Moreover, it is not unusual to appoint managers who know little of the skills of the professionals they manage. Sometimes those generic managers are not only ignorant but unsympathetic.

 

There has always been a tension between managers and professionals. But it seems sharper today. Three decades ago academics expected to be proud of their university. If some aspect was dysfunctional that was considered a temporary aberration. Today, most academics seem to consider the university management is dysfunctional all of the time. Those who worked in hospital boards or DSIR divisions before the changes report a similar shift in attitudes.

 

I used to think the problem arose from a combination of the institutions being under very tight budget constraints and yet subject to less stable funding, that the senior management of these institutions are more responsible for setting remuneration than they once were, and that the professionals did not understand the changes.

 

The justification for the tighter funding constraints was the belief that there would be gains from the resulting new management styles. Most explicitly the 1988 Gibbs report, Unshackling the Hospitals, made the unsubstantiated claim that there were major productivity improvements to be made by introducing business practices into the public hospital. Gains of 20 to 30 percent were explicitly mentioned, although the evidence to back the rhetoric was thin, and never verified.

 

Tighter budget constraints have certainly exacerbated the tensions between the managers and their professionals. But if professionals still do not understand these changes after almost two decades of reforms, that is – at the very least – an indictment that the managers have failed to get across the changed circumstances.

 

Reluctantly I have come to the conclusion that the problem has persisted too long to explain simply by the change in the external environment. We have the tension between modes of organisation which troubled Schick. The breakdown is because the two groups have very different – and apparently irreconcilable – cultures.

 

The public administration parallel to ‘marry in haste, repent in leisure’ is ‘reform in haste and undo the reforms painfully over a long period’. Many of the organizational reforms have been undone, but there remains the culture of business management.

 

One anecdote will do. A doctor complains that a manager closed beds in his ward without any discussion with the staff involved. The doctor was not questioning whether the beds should have been eliminated – how could he know all the issues if he was not informed? His concern was the lack of consultation, for under this managerial regime those lower in the hierarchy need not be involved, even though the upper level managers do not have the professional competence to evaluate the effect of a decision on patients. Perhaps not surprisingly, two health professionals left the ward as a result of the failure to consult.

 

I do not know the managers’ response to this complaint. If they dont consult they dont get a chance to respond to criticisms. It would seem they considered that resource management was their job, and not the professionals’, even if it affected the quality of care. Apparently empty beds are part of the management of cross-infection. It is said that because managers removed beds without consultation with professional health workers, there have been consequential deaths from cross-infection. [2]

 

If you believe Theory X, you will argue our doctors and nurses are underpaid internationally, and that the problem of staff loss and shortages could be resolved if they were paid more. What is needed, then, to resolve the tensions and demoralisation is more public sector funding which will reduce pressure from the budget constraint, and enable better remuneration of the professionals.

 

While there may be some truth in such arguments, they are also an admission of failure. There have not been the productivity gains which the reforms promised, nor the improved working conditions which might have led to the quality gains that productivity measures ignore. The huge gains promised by the Gibbs’ report in particular and the commercialist reformers generally have failed to materialise. The changes based on the New Institutional Economics have failed.

 

Is the problem transitional to be resolved when a new generation of managers dominates the old ones who learned their trade in the earlier era? Not only does that day seem some way off, but insofar as Theory X is antagonistic to professionals’ values, their ethic of responsibility may be destroyed. In which case a slow transition will be too late. Trying to deal with the tensions in the interim is not going to work.

 

The Foundation for Research, Science and Technology is currently moving away from simply ‘purchasing’ research (note the commercialist jargon) from Crown Research Institutes, to looking at the internal processes within them. As a general rule, when one is purchasing from a firm, one does not look at its production processes. Are not the internal processes part of the ownership concerns and not the purchaser concerns? So why the extension of attention by FRST? Were not the reforms about abandoning funding of agencies on the basis of their inputs and focussing on their outputs? Is not this a return to input monitoring?

 

Well yes, but looking at inputs, outputs and the processing between makes sense when the output of the agency is not well defined. Indeed Schick recommended this more comprehensive approach, even though this abandons a key element of the reforms. The new FRST monitoring regime has been presented as fine tuning, but the mere fact that it is necessary demonstrates the failure of the underlying settings and theory.

 

The addition of input monitoring is patching the system. It is not obvious it will be an improvement. FRST monitoring the internal processes of a CRI could reduce the ability of managers to manage, and even exacerbate the tensions between managers and professionals.

 

Moreover, there is not just one patch, but patches upon patches. I am reminded of the dying days of the Muldoon era. The assumption was that anti-market regulation was sound, and any defects could be resolved by just a few more adjustments, and then a few more, and then a few more … As the interventions accumulated, it became evident that there was something profoundly wrong with the underlying system.

 

We may have reached that point with the corporate governance model of the public sector. It is no longer a matter of commercialism working if only a few further adaptations are made. Commercialism is not working.

 

What is the alternative? We need to return to a foundation of public sector governance of Theory Y and the Public Sector Management model based on the trust that professionals will do their best. Of course we they should be required to meet high professional standards, but any contractualism should not dominate their professionalism.

 

Under the new regime both ‘managers’ and ‘professionals’ must change. The professionals need to understand better how the system works and how they have to be responsible for the resources they use. The change required of managers is even greater. No longer would they be on top of a Theory X hierarchy, but in parallel with the professionals with a mandate to facilitate the sharp end of their agency not to govern it. The real test will be when the managers are cooperatively working with their professionals, because the managers are proud of their own professionalism.

 

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Endnotes

[1] I am grateful to Rob Bowie, Paul Gandar, Alan Gray, Don Gilling, Jas McKenzie and Diane Salter for sharing their experiences and insights in response to various earlier versions of this paper. They are not responsible for the final paper.

[2] It was originally applied to monetary policy.

[3] L. Quaintance, ‘Is Our Health System Safe?’ North and South, November, 2000