1 Introduction
In the decade after 1984, New Zealand implemented a programme of state sector reform that placed it at the forefront of international debate about the scope, structure and management of public-sector activities in modern developed economies. Today, the New Zealand public sector continues to operate within the framework for public management laid down in that period.
New Zealand's model of public management had its origins in the ideas of reform-minded politicians and policy advisers who found support for change in the academic literature in economics, accounting and management that had emerged during the 1970s and early 1980s (Scott, 2001). In respect of economics, many of those ideas related to the development of institutional economics, and in particular its focus on:
- Transaction costs as explanations for the organisation of firms and markets.
- Principal-agent theories of economic interaction, particularly the cost of acquiring, and the asymmetric distribution of, information, and the pervasiveness of moral hazard and adverse selection in management and contracting problems.
- Contestability and a rethinking of the importance of competitive markets in maximising consumer surplus and social welfare.
These developments in the academic economics literature provided theoretical support for advice that supported a large-scale reduction in government ownership of commercial activities, and substantial changes to the way in which what remained in the public sector was managed.
This study considers what has changed in the academic literature in microeconomics over the past 25 years, and how those changes in the literature might inform new thinking about the role, structure, and management of the public sector. One would hope that, as a result of the research efforts of tens of thousands of academic economists around the world, the answer would be that much has changed—and indeed it has.
To keep the task manageable, we have focused our analysis on developments in those fields that relate directly to contemporary policy issues. In particular, we focus on developments in three broad areas of microeconomics:
- incomplete contracts, ownership rights, and the theory of the firm
- agency relationships, governance and incentives inside the firm, and
- real options and investment.
Each of these areas of literature has implications for a wide range of contemporary policy issues including public ownership, investment and divestment, the effectiveness of governance and management in the state sector, and alternative models of state service delivery. Inevitably, a range of active research programmes in microeconomics, including those in game theory, behavioural and experimental economics, and law and economics, are not considered, or are considered only tangentially as they touch on the literatures in the core areas identified above.
In each case, the task of this paper is to identify those developments in the literature that have relevance to current policy issues including interest in reducing the scale of, and increasing the return from, public expenditure, and the rationale for public ownership of a wide range of activities. Where possible, we use elements of the current organisation of the public and private sector to illustrate the points made by the (largely) theoretical literature. However, we have not attempted to provide advice about particular policy issues, since one of the lessons obtained from the increasingly rich and diverse literature in microeconomics is that careful analysis of each issue rather than vanilla policy prescriptions is indicated at every level.
The paper follows the literature in economics and management in focusing on questions of efficiency and social welfare or total surplus maximisation as the benchmark against which organisation and decision structures are assessed. Much of the work that we consider is drawn from a theoretical literature that uses the language of private-sector management and decision-making, but this does not reduce its relevance to issues in public management—indeed it is an important strength. The rigour of academic economics derives in part from its methodological precision in the analysis of the issues being studied, and its ability to separate questions of efficiency from questions about political objectives and income redistribution. Questions about the complexity of the public sector and the valuation of different outcomes normally reflect political and distributional issues about which economics and management have little to say. The benefit to be obtained from the application of economics to public management is to obtain for the public sector the benefits of efficiency and social welfare maximisation, creating wider degrees of freedom to consider political valuations and redistribution, as well as a clearer understanding of the implications of those choices for the wealth of society as a whole.
Following a brief outline of the scope, structure and management of the public sector in New Zealand as it has emerged from the post-1984 reforms, we begin in Chapter 2 with an analysis of recent developments in the theory of the firm and ownership. We point out that the incomplete contracts literature which is now the focus of attention in this literature provides a compelling theory of ownership which is a substantial advance on the literature of the 1970s and early 1980s.
In Chapter 3, we summarise the literature on real options and investment. A contribution of our work is to point out that the exercise of real options is a substantial example of contractual incompleteness, where the allocation of ownership rights to a party who can exercise the real options is critical for efficient investment decision-making.
In Chapters 4 and 5, we utilise the insights of the incomplete contracts and real options literature to consider aspects of public and private-sector ownership, service delivery and procurement. Chapter 4 focuses on the case where services are associated with the construction of a specific capital intensive facility (prisons being a commonly used example), while Chapter 5 considers public and private service delivery in the absence of a requirement for specific capital investment.
In Chapter 6, we consider governance in the public sector, utilising the incomplete contracts framework. We point out that the role of governance is to allocate residual decision rights that allow resolution of contractual incompleteness, and we provide an assessment of whether the current governance and monitoring arrangements for in the public sector are consistent with this.
In Chapter 7, we consider the current literature on personnel management, particularly internal labour market tournaments, teams, and compensation, and some applications of this to the public sector.
In Chapter 8, we consider the literature on coordination and decentralisation, and show how the findings of this literature may assist analysis of the optimal scope and level of decentralisation in individual public-sector organisations and in the public sector as a whole.
Our conclusions are in Chapter 9.
