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Investing well

Investment and disposal decisions (see Box 5.2) need to be considered within a comprehensive framework that systematically analyses alternative choices so that highest value options are chosen. This means assessing not only the costs and benefits of the method of delivering an objective, but also which objectives to prioritise.

Box 5.2 - Divestment in the public sector

Good balance sheet management relies on the ability to sell assets that are no longer needed to allow for capital reinvestment. The ability to reprioritise assets and recycle capital is key to balance sheet flexibility and avoiding unnecessary and costly asset holdings.

However, before Crown assets can be sold there can be a number of legal and policy requirements to be fulfilled. For example, the creation of the MOM companies required legislation. But even smaller scale and ordinary asset sales can require a number of legislative and policy requirements to be met. For example, Cabinet has decision rights over any departmental asset based divestment proposal that exceeds $25 million or is high risk. Moreover, the disposal of any Crown-owned land is subject to a range of statutory and government policy requirements. The particular requirements will depend on the legislation under which the land is held, but can include the Public Works Act and Treaty of Waitangi obligations.

In general, disposing of Crown property is a lengthy, complicated, and costly exercise because of these legal and policy obligations. This can discourage active balance sheet management of assets surplus to requirements. For this reason the government has established the Crown Land Centre of Expertise within Land Information New Zealand (LINZ), which has specialist knowledge to assist with these processes.

The decision making framework needs to take account of the following factors:

  • The overall expected economic costs and benefits of the investment proposal (see Box 5.3 for a discussion of this in the context of financial and commercial assets). This process can be challenging in a public sector context as there are also non-financial considerations to be incorporated such as those outlined in the Living Standards Framework. For example, it is hard to quantify the value of an investment in a courthouse to social infrastructure.
  • The project’s fit with existing assets and services within the wider state sector. This is especially the case where assets are part of a highly integrated system (eg, roads, schools, health system or the delivery of defence capability).
  • The risks and likelihood of an investment meeting its objectives, taking into account agency past performance, asset management maturity and delivery capability.
  • What resources are already being applied to meet that objective and/or whether other resources could be reallocated for better use.
  • The profile of future investments including costs, benefits and spending pressures that may emerge.

Investment outcomes also need to be carefully assessed against forecast benefits and costs. Systematic ex-post review helps support continued improvement in the investment decision making framework by providing an important feedback loop to the process.

Box 5.3 - Financial and commercial assets, risk and return and cost benefit analysis

When making an assessment as to whether to invest in financial and commercial assets both risk and return must be accounted for. Thus, making the case for investment on the basis that government borrowing rates are lower than the expected returns available on financial or commercial asset is not sufficient.

Financial and commercial assets have a higher expected return than government borrowing because of their greater risk. Their higher expected return compensates an investor for the chance that these assets may decrease in value. Because of this, a decision to invest must take account of risk tolerance - that is, how much additional return is required for the increased risk.

In a government context this is difficult, as individuals' risk tolerances vary. Also, and always, governments should only intervene where they are either more efficient than the private sector in doing so, or the private sector will not or cannot provide the intervention.

For these reasons, the Crown should only invest in assets for which there is an underlying reason for ownership. For example, in the case of the NZSF, this is to part fund the increasing future costs of superannuation benefits.

Assessment

Based on the initial assessment in this Statement, the public sector management system has some of the features required for effective capital decision making. However, even where individual agencies are making rational decisions from their perspective, they may not be ideal from a whole of government perspective.

Each year through the budget process a new capital allowance is made. New investment alternatives compete for this capital. They are assessed with a whole of Crown lens and decisions to invest are made by Cabinet. The budget process is supported by departmental four-year plans which provide a longer term view of agency needs and plans.

However, these capital allocation decisions are not always supported by rigorous cost benefit analysis. Typically funding is conditional upon further analysis in the form of a business case. In addition, decision making is not systematically supported by analysis of agency capability, what it currently owns, or the utilisation and condition of these assets. Improved information about Crown assets would give a better understanding of needs and enable judgements on whether capital is meeting current objectives or could be put to more productive uses.

Both the quality of cost-benefit analysis and planning could also be improved. With cost-benefit analysis there is some evidence that its practical application often overstates benefits and understates costs of projects.[47] In addition, planning horizons are currently too short. Planning over a longer term would further support decision making, especially for capital intensive but less frequent projects. Systematic review of project outcomes against expectations would also improve incentives on agencies to analyse investments accurately.

Investments made using the funding that agencies hold specifically for the replacement of existing capital, or from their own asset reprioritisations, or from specific revenue streams, are not subject to a systematic whole of Crown prioritisation process.[48] This contrasts with the oversight applied to new spending decisions through the budget process.

There is no formal process to ensure capital investment funded this way aligns well with overall government priorities. While this may already be occurring to some degree, a more systematic approach would better ensure that it does.

This also makes it more difficult for the government to manage its overall fiscal strategy. Ideally investment timing should take into account prevailing economic conditions.

Capital spending funded in this way is the majority of total investment made each year. In recent years the Crown has allocated around $1 billion of new capital at each budget, this compares with annual capital expenditure of around $7 billion of capital reinvestment.

Notes

  • [47]See http://www.infrastructure.govt.nz/publications/betterbusinesscases/guidance for a discussion of bias in cost benefit analysis.
  • [48]Cabinet retains some decision rights with respect to major capital projects. See http://www.dpmc.govt.nz/cabinet/circulars/co10/2
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