Economics: Public sector must change its culture

THE PROSPECT of a pounds 50bn budget deficit promises to give the public spending round an unusual dash of spice. The leaks have begun. The position papers are being written. Spending ministries want the cuts in someone else's back yard, and the Treasury is nursing its customary anxiety about an Italian-style national debt.

This conflict between spenders and controllers has a rhetorical parallel in Parliament. British politics is still mired in a debate where left- wingers want more spending and right-wingers want less. This battle would be regarded as plain daft in any company, where it is a truism that you sometimes need to spend money to make it. The far more interesting question is whether we have the right kind of spending.

Contrary to the declaration in the Government's 1979 White Paper that public expenditure lies at the root of our economic problems, there are whole categories of spending that complement private sector activity. After all, the Confederation of British Industry wants more roads, because they cut costs and make industry more competitive. It wants more training, because it will enable business to make higher value added processes and products. We clearly spend too little on both physical and human capital.

But Labour's willingness to assume that more spending means better is equally odd. There can be no reason save Labour's embarrassment about its unilateralist past why it is failing, for example, to argue for deeper defence cuts. Even after the planned reduction, defence will still take 1 per cent more of our national income than other European countries, except France. If ever there was a time for reining back the imperial overstretch, this is surely it.

The left's lack of willingness to question the quality of public expenditure is also ultimately self-defeating. There will only ever be a consensus behind public spending programmes to relieve poverty, sickness and ignorance if they can be shown to be effective. One weevil undermining backing for the welfare state is an arrogant bureaucracy that treats tenants or claimants like serfs. Another is public suspicion of waste, corruption and bloated payrolls. Every T Dan Smith and London Borough of Lambeth is another hammer blow against the legitimacy of high taxes.

This issue of how the public sector spends money - of its techniques of control, accountability and efficiency - receives too little attention. With a few exceptions such as Michael Heseltine (who introduced the MINIS reporting system at the Ministries of Defence and the Environment), ministers are usually happy to fall in with the traditional distinction between policy issues (in which ministers are allowed to be interested) and management issues (which they can leave to mandarins).

But management of such enormous resources is crucial. Total government spending in 1993-4 is meant to come to pounds 287bn, or some 45.5 per cent of national income. Broadly, a little less than half is merely shuffled from one lot of people in the private sector to another, in the form of either pensions, benefits, subsidies to industry or interest payments on debt. A little more than half is spent on goods, services and public employees. The public sector directly manages about a quarter of all the spending in this country.

Given the changes in the management of private sector businesses, we should equally expect a revolution in the public sector. Management theory teaches us the benefit of focusing organisations on key objectives, of measuring organisations' worth by what they produce rather than what they consume in inputs of capital or labour, of flattening hierarchies in an increasingly professional world, of decentralising power.

Some of this has been taken on board. The Treasury has certainly tried to develop output measures, with varying success. (Look at how the teachers hate the idea of parents being able to tell how well a school meets its academic objectives: every profession prefers to be judge of its own performance, because every profession, as Shaw wrote, is a conspiracy against the laity.) A big change has been the development of the 'next steps' agencies. More than 300,000 staff and 70 divisions (such as the Passport Agency and the Benefits Agency) are now autonomous units with their own management, budgets and pay grades.

But a fascinating new book that is currently taking the Clinton administration by storm suggests that Britain's public sector could go a lot further. In Reinventing Government: how the entrepreneurial spirit is transforming the public sector,* David Osborne and Ted Gaebler look at management successes in the US public sector. The first revelation is the sheer number of experiments in different states and cities, a variety that our rigid controls over local government would sadly not allow.

In the US, one of the incentives behind rethinking public spending has been the middle-class revolt against taxes. Visalia, a small Californian town of 75,000 people, suddenly lost 25 per cent of its tax base when Proposition 13 was voted through in 1978. One response there and in many other cities was to adopt an entirely different budgeting system: the expenditure control budget.

Visalia made two simple changes to the budget system used by most governments (and by a lot of big businesses). It eliminated all line items within departmental budgets, freeing managers to move resources around as their needs shifted. Out went artificial divisions between capital and current spending, and closely guarded totem programmes. Second, it allowed departments to keep any savings from one year to spend in the next. They could move unused money to new tasks.

'Normal government budgets encourage managers to waste money,' the authors write. 'If they don't spend their entire budget by the end of the fiscal year, three things happen: they lose the money they have saved; they get less next year; and the budget director scolds them for requesting too much last year.' This is as true in Britain as in the US: every financial year in March, there is a last-minute spurt as departments try to spend up to budget.

Under Visalia's new ECB system, managers were allowed to react quickly, enabling them to make big savings in procurement. They acquired a new Olympic-size swimming pool on the cheap, started a new low- rent housing scheme by giving land to a non-profit organisation, cut energy consumption of the vehicle repair shop by 30 per cent, pioneered new lease-purchase programmes for police cars, and built up a reserve of dollars 20m by 1985 when other authorities were gasping from tax shrinkage.

East Harlem, a ghetto where a third of the population is on public assistance, is another interesting example. Twenty years ago, it was 32nd out of 32 New York school districts measured by test scores. Only 15 per cent of pupils read at grade level, and attendance rates were alarming. By 1988, 64 per cent read at grade level. The number of children going on to the city's four elite public high schools leapt from fewer than 10 a year to 139 in 1987.

The secret was introducing competition between schools, with the pupils making the decisions about where to go. Starting gradually with one non-traditional school built around a core curriculum, the district gave pupils more and more choice. Schools were no longer synonymous with buildings: some housed three or four schools, one on each floor. Before long, the junior highs were competing for students. Successful schools that reached 300 pupils cloned themselves; unsuccessful ones closed.

In East Harlem's case, teachers continued on the public payroll. But greater flexibility can and should mean more contracting out, using the private sector when it makes sense. The public sector needs to decide what should be provided collectively, but it does not have to run that provision itself. A road built by a private contractor is not necessarily a private road. As Mario Cuomo, the liberal Democrat, is quoted as saying: 'It is not government's obligation to provide services, but to see that they are provided.' Entitlement rather than provision should be the watchword for the new public sector.

In both the US and Britain, the cautious and measured culture of the public sector grew up as a response to the corruption, patronage and sale of offices during the 19th century. The Northcote-Trevelyan reforms in Britain were mirrored by the US Progressives' reforms. Civil service exams stopped nepotism. Rules and long chains of command, each level checking on another, made corruption more difficult.

But those rules also stifled initiative and encouraged paper-pushing. Implicitly, they say: 'You're stupid. We don't trust you.' Rules made it more important to avoid mistakes than to achieve successes. That may not have mattered much in a relatively simple world delivering simple services, but it looks much less appropriate now. The inflexibility that those procedures introduced into the system has outlived its usefulness. Long live a public sector that sets clear goals, takes risks, experiments - and even makes mistakes.

* Addison-Wesley Inc, Reading, Mass.