Taking a Stewardship Approach to the Public Finance System

Struan Little: Deputy Secretary, Budget and Public Services, the New Zealand Treasury

Speech notes for 4 December 2018 speech, Victoria University of Wellington: School of Government

Earlier this year, the Secretary to the Treasury, Gabriel Makhlouf, gave a speech outlining the three pillars of macroeconomic management.

One of these pillars is fiscal policy and how it is given effect by the Public Finance Act. I'd like to end the year by elaborating a little more on this fiscal pillar and talking to you about the public finance system — where we've come from and where we're at, why we need to change, and where I think we need to go to next.

The vision#

At a very high level, the vision that we've (the Treasury) set out is a public finance system that enables the public service to improve the intergenerational wellbeing of New Zealanders.

Will, we ask, the current public finance system enable us to achieve this vision?

The existing model#

The reforms of the 1980s, and the 1989 Public Finance Act (the PFA) – which will next year be 30 years old – introduced important features to the public finance model at a time when the country was facing serious issues:

  • Fiscal sustainability was paramount (for example, there were significant increases in government debt levels – with net debt subsequently reaching 55% of GDP in 1992);
  • There was relatively little transparency around public spending; and
  • The public sector was, it's fair to suggest, generally not responsive to Ministers.

The reforms were targeted at addressing these, what I'll call, deficiencies. They replaced an 'input-focused' approach with a managerialist, output, and performance-focused model.

The new 'regime' was based on principles of devolution, accountability, and transparency. Alongside this was a change to accrual-based accounting to assist with better decision-making.

These changes represented a sea change in the approach to public finance.

In the years that followed, the framework was supplemented with a further focus on fiscal responsibility – including the introduction of fixed nominal baselines and the Fiscal Responsibility Act. These acted to complement improved financial decision-making with a firm fiscal sustainability focus.

In many ways, the current model and those reform changes have been highly successful:

  • New Zealand ranks relatively closely to the top of many international transparency, corruption, and wellbeing comparison metrics (for example, OECD, Legatum, Gallup, and the Open Budget Survey) – and ranked first in the 2017 Open Budget Survey;
  • The public sector is much more responsive to Ministers and the government at large;
  • The fundamentals of our economy and public finance system are strong –
    New Zealand's fiscal outlook is strong compared to other countries: in the year to June 2018, the operating balance before gains and losses (OBEGAL) reached a surplus of $5.5 billion and net debt fell to 19.9% of GDP; and
  • Outcomes in critical areas like health, education, and employment are relatively strong.

In contrast, the majority of OECD countries have been grappling with fundamental macro, fiscal, and public trust challenges.

The case for change#

One benefit of New Zealand's strong position is that we now have the opportunity to look beyond financial outcomes and pay more explicit attention to a wider set of outcomes.

We can see this developing emphasis in the work of agencies like the OECD and their Better Life Index, the work of the (New Zealand) Treasury on the Living Standards Framework, and the current government's emphasis on wellbeing and moving towards the May 2019 Wellbeing Budget.

These challenge our existing financial management system to ensure that it actively supports attention on a wider focus of outcomes.

At a more practical level, we also know that the system is not working well for everyone – it particularly struggles with responding to complex issues and longer-term opportunities and risks facing the country. For example, we have made limited progress on issues of inter-generational disadvantage despite their importance to lifting the wellbeing of New Zealanders.

These issues stem – in part – from a range of underlying issues with our public finance settings and how they tend to be operationalised.

For example:

  • The current financial and vertical accountability structures incentivise silos – good for delivering discrete, tangible outputs that are delivered by a single agency, but creating a barrier to helping those with complex needs and tackling complex issues that fall across departmental boundaries.
    For example: in the social sector, evidence shows that people with complex needs would benefit from 'navigators' to help them interact with different agencies. Many agencies developed navigator programmes, however this sometimes meant that people then had multiple navigators – one from each agency.
  • The financial management system of annual appropriations and 4-year fixed nominal baselines incentivise a focus on the short-term with the risk that longer-term planning and capability building are deferred.
    For example: the amount of time agencies spend on doing their year-end wrap-up, despite most of what the public sector does neither beginning nor ending in June/July (ie, the work is often ongoing beyond any particular financial year).
  • The Budget, baseline, and appropriation settings, while flexible in theory, can in practice be a barrier to moving funding across outputs and years when it makes sense to do so.
    For example: The on-the-ground collective that had some funding to spend to meet its outcomes, but which couldn't get approval to spend this on it (despite this being the best intervention) because it was capital, not operating funding.
  • Despite the flexibility included in the PFA by way of amendments in 2013, the performance accountability conventions for estimates, annual reporting, and numerous strategic planning requirements have emphasised outputs and consequences for failure.
    This has implicitly driven a focus on compliance and aversion to risk, and provides a barrier to innovation; and
  • There can be a lack of incentives and relatively little focus on evaluation and other mechanisms for driving a learning-oriented system and a longer-term view.

The original intent of the overall reform 'programme' was to bring flexibility and to only place an upper limit on spending.

The effect of all these changes, though, has been the creation of an 'electric fence' around the fiscal management system – and a system that won't allow us to achieve our vision.

The role of Parliament#

Not only are we missing some of the pressing public policy challenges, but I would also contend that we are not serving Parliament nearly as well as we could be.

One long-standing core feature of New Zealand's parliamentary democracy is that the Executive (the Crown) can spend money only if authorised to do so by an Act of Parliament. In essence, there is a bargain under which:

  • Parliament authorises the Executive to spend money by passing Appropriation Acts; and
  • In return, the Executive provides Parliament with information on:
    What is intended to be achieved with that spending; and
    How much has been spent and what has been achieved with that spending.

The question I would pose is this: how well are we, a Crown agency – as part of the Executive – keeping our side of the bargain?

Although successive Finance and Expenditure Committees have been consulted on the format and content of Estimates, we provide Parliament with enormous detail that can be difficult to absorb.

The focus is largely on annual data, when there's an opportunity to provide the Committee with trend-based information that can better support strategic decision-making.

Amidst the mountain of detail is rather less about what is being achieved in terms of outcomes. We risk running a system that, effectively, tells the customer what it wants to buy – rather than designing it around the taxpayer.

Evolution of the system#

These issues with the system are not new. Successive administrations have tried a range of solutions over the past 30 years to try to get the performance and the information they have been seeking. These have included:

  • Third party monitoring to drive performance in specified sectors or projects. The programme of Major Projects Reporting is an example that grew out of some high-profile performance failures;
  • Reporting tools for focusing on long-term planning (such as 4 year plans, long-term investment plans, and Statements of Intent);
  • Single purpose vehicles for achieving focus (for example, an entity, Crown Fibre Holdings, was set up to drive broadband roll-out);
  • Outcome-based indicators for driving focus on the long-term. For example, previous administrations' Strategic Results Areas and Better Public Services targets;
  • Input controls for driving efficiency. For example, capping the number of employees across the public service can be seen in light of this; and
  • Partial re-centralisation of decisions to reach more coordination. For example, designated agency-based functional leads in areas like ICT, procurement, and property.

My point is not to contest the effectiveness of any of these approaches – indeed, some of these changes haven certainly taken us closer to more effectively addressing complex issues.

They have, however, led to what I might call a 'patchwork' system – one with inconsistent underlying philosophies as well as huge increase in compliance costs and a greater focus on activity instead of strategy. The irony is that the overall effect of these changes can be to take us further away from a more meaningful performance framework.

The work that we, the Treasury, are doing on the Living Standards Framework and on preparing for the Wellbeing Budget will, I feel, take us a step forward.

They will though, I think, take us only so far if we don't look at some of the underlying public finance settings and how these are being operationalised. The risk is that this could compromise yet another set of valuable resources being added to the overall system.

Where we need to go#

Instead of more what I might call 'band-aid' solutions, it is, I feel, time to re-think our approach to public financing – alongside the State Services Commission's current and important reform work – to support a more modern, agile, flexible, innovative, and joined-up public sector.

The change we need is a philosophical and cultural shift from a 'management' approach to a 'system stewardship' approach.

In my mind, this change in approach involves four key shifts we need to focus on at a system level – which comprise the 'what' of system change:

  • First: considering the creation and safeguarding of value while maintaining a focus on fiscal responsibility;
  • Secondly: supporting better system collaboration;
  • Thirdly: greater emphasis on the long-term to support innovation, asset management and capability-building; and
  • Fourthly: fit-for-purpose system settings and reporting that improve strategic focus, accountability, transparency, and performance improvement.

This also involves changing how we go about achieving these shifts, and moving away from what has become a hierarchical, top-down control model, and a one-size fits all approach.

We need to build a system leadership model – an approach that involves more sophisticated regulation of the system by taking a more differentiated and proportional approach, and supporting partnerships, co-design, and greater flexibility.

So, what might this mean in practice?

Let's take the need for more innovative service delivery functions as an example. There is an opportunity to learn from some large innovative companies: they do not simply undertake their financial management by providing greater financial flexibility for all parts of their business – rather, they manage the bulk of their business as 'runs' and specify some innovative areas as 'change'. This means funding and reporting requirements that differentiate between:

  • When the company should focus on outputs, improving efficiency and minimising compliance; and
  • When it should focus on complex long-term problems that require innovation, collaboration, and evidence of effectiveness.

I can see the design of financial management systems that allow for differentiating more on what the aim is to achieve – whether this is more 'runs' or 'change' – and providing more flexibility for the parts of the system where more innovation is needed.

To be clear, I'm not suggesting a wholesale overhaul of the system. I am determined to retain the existing and very sound principles of fiscal responsibility, and the high levels of transparency and accountability to Parliament – clearly these are strengths of the current system.

I am suggesting being smarter and more flexible about how to apply these principles in different circumstances to meet the complex needs and challenges faced today.

I'd put it like this: the foundations are secure – it's the superstructure that needs some work.

I'd suggest that – from Parliament's point of view – the need to maintain the fundamental bargain I spoke of earlier is important: the Executive should be providing Parliament with information on spending, in return for Parliament authorising the Executive to spend.

I do, however, think the question needs to be asked: can Parliament be given more meaningful information to help with this?

There is, I feel, much wider scope for change within executive government: all aspects of the system should serve a useful purpose, and be effective and efficient. If they're not, they ought to either be changed or done away with.

I would also note that at the moment consideration is focused on the 'core Crown', and doesn't consider the role of Crown Entities. At a later stage, it ought to be considered how these entities will fit within the overall picture.

What might this look like?#

The systems and issues we're grappling with are complex – we need to be exploring changes across multiple fronts and levels. This therefore means taking considerable care as to how we develop and implement changes.

We, the Treasury, have started exploring how this approach could be applied to some of our core public finance system processes – while at the same time exploring some bigger, including potential legislative, changes.

Four areas of focus#

I'd like to finish today by highlighting for you four areas in which we've focused our early activity:

  1. We're doing some future budget design work that is exploring this: how to increase financial flexibility and support a medium-term focus – through using baseline reviews for setting funding for a multi-year period in lieu of the annual resource-intensive process of cost pressures bids.
  2. We're looking at how we can provide greater flexibility around appropriations, to allow funding to be shifted across years and output classes, through either aggregating appropriations or greater use of multi-year and multi-category appropriations where appropriate.
  3. We are reviewing the current strategic planning and reporting regime to identify opportunities for simplifying the current requirements and driving a greater focus on strategic decision-making, performance improvement, and a focus on collaboration (eg, collective reporting).
  4. Lastly, we're working on better long-term investment outcomes by getting better information on the investment pipeline, improving asset management practices, and working with agencies on improving their investment management systems and building capability.

We've been doing this work alongside some initial changes that are being proposed, by the government, to the PFA.

This legislative work involves amending the PFA as part of the Child Poverty Reduction Bill. Consultation processes were also recently undertaken on two proposals aimed at putting into legislation:

  • An enduring focus on wellbeing alongside fiscal responsibility; and
  • The establishing of an independent fiscal institution that would improve democratic policy-making and provide independent evaluation of fiscal policy performance.

Changes have also been proposed to better support agency co-operation through modifying appropriation settings as part of proposed changes to the State Sector Act 1988.

  • My point here is that some of the more far-reaching changes will require changes in legislation. If we accept that the underlying principles in the current public finance system, ie its framework, remain robust, there is plenty that can be done within current legislative parameters.

To make it a reality, however, there will need to be support for a cultural shift within the Treasury and the wider public sector that supports the evolution in philosophy I've spoken of this afternoon.

Meeting the challenges#

Thank you for taking the time to listen to me today – and thank you to the School of Government for hosting me. I will leave you with the main points I've endeavoured to emphasise, after which your questions would be welcomed.

The existing financial management system has served the country well for a long period of time.

It is, though, after 30 years (of the PFA), timely to consider the opportunity for change to the system – which is struggling to meet the complex needs of today's policy issues and to effectively enable an increasingly wide range of financial and non-financial outcomes.

To meet these challenges, I believe that we need a philosophical and cultural shift – from a 'management' approach towards a 'system stewardship' approach.

This approach includes being smarter and more flexible with how we apply the already sound principles of fiscal responsibility, high levels of transparency, and accountability to Parliament.

While elements of this change may be far-reaching, there is much we can do within our current Parliamentary authority to bring about greater intergenerational wellbeing for New Zealanders.

We are ambitious for this country, and for the future of intergenerational wellbeing – it is, therefore, important that underlying institutions such as the public finance system can well support this ambition.

Thank you.