This is primarily a workbook for students of public sector financial management in Australia. It is written for managers in the public sector, at any level of government, and for those who, while not in the public sector, have to deal with governments.
Recent years have seen many upheavals in public sector management. There has been much useful and overdue reform. There have also been some well-intentioned but misguided innovations. Some of these have arisen from attempts to treat the public sector in the same way as the private sector, without taking into account the unique tasks faced by governments. There has been a movement, under the misnomer "economic rationalism", to try to strip away many functions of government. But there is a role for government, and it is based on perfectly rational and sound theory. Certain goods and services cannot be supplied in private markets; there is nothing rational about restricting the public’s access to these goods and services in the name of a paternalistic dogma which dictates that the products of private markets are somehow superior to the products of public markets. The case for "smaller government" is centered on conservative political correctness, not on any set of economically rational criteria. I have endeavored, therefore, to provide a coverage of market failure and public goods theory, so that students can clearly distinguish which functions most appropriately fit into the public and private sectors.
One result of the reforms of the eighties has been the development of a distinction between financial management and economic management. This is demonstrated by the separation in the Commonwealth of the Treasury into the Departments of Finance and Treasury – one agency concerned with financial management and the other with economic management.
Financial management, however, does not exist independently. While prudent financial management is beneficial in its own right, it should be subordinate to and constrained by government economic policy. All financial decisions should have some goal or objective, above and beyond simple compliance with financial directions. A firm which limits its financial management to keeping correct ledgers, maintaining a chart of accounts, keeping its cash balanced, and producing correct annual statements will be lucky to stay in business. Obviously if it is wasteful it will suffer; less obvious is that undue parsimony will also lead to ruin.
Likewise for the public sector. For example, cost recovery in the Australian Bureau of Agricultural and Resource Economics may appear very desirable from a financial management point of view. But there are reasons for having a publicly-funded data collection and commodity research service. There are economic efficiencies in making information available at marginal, rather than average cost. In the health care area it may be very tempting for a government to save on budgetary outlays by encouraging private health insurance, but that would add significantly to the community's aggregate health care costs. Simple concern with minimizing budgetary outlays can encourage inefficiencies and cost-shifting. At a more modest level it may look very attractive for a manager in a government agency to lease a piece of equipment like a truck or photocopier, rather than having the full purchase taken out of this year's budgetary allocation. But is it a wise use of the public's resources? Only with some knowledge of evaluative techniques, such as discounted cash flow analysis, will managers make wise recommendations and decisions in such situations.
This work is centered on two assumptions:
(1) That in managing the community's financial and other resources, public sector managers need to understand the broad framework of government economic policies. They need to understand justifications for government involvement in the economy, both at a macro level (fiscal and monetary theory), and at a micro level (market failure and public goods theory).
(2) That these managers need techniques for making allocative recommendations and choices. They need to understand the principles of costing, pricing, investing, ‘make or buy decisions', as would their counterparts in the private sector. Compared with their private sector counterparts, however, they have a more difficult job in that they are far more accountable for their decisions. They may be called on to explain the reasons for their decisions and recommendations in a public arena, such as a parliamentary committee.
This accountability places heavy responsibility on public servants. Without an adequate theoretical basis for explaining the reasons for their actions, public sector managers will find it hard to justify sensible proposals and may face criticism which they cannot defend. A private company which makes a large profit is deemed to be successful. A power utility which does likewise is deemed to be exploiting its monopoly situation. How then does an electricity authority justify accumulating reserves to replace ageing equipment? A private airline which loses money consistently will go out of business; public transport utilities can go on accumulating losses. What is a reasonable benchmark to measure the performance of a public transport operator? A private company can decide to drop unprofitable product lines. Telstra, however, must maintain a public phone service, and provide a service to Oodnadatta, as mandated community service obligations. How should resources be allocated to such activities which can never reasonably be profitable, and how should they be costed? A private company provides goods and services wherever it can find customers. The public sector has to provide public goods, where no markets or very imperfect markets exist. What are the justifications for public provision?
Herman Leonard, of Harvard University’s John F Kennedy School, once said, "The hard jobs are left to the public sector". These are the hard jobs, and the public sector manager needs a robust theoretical framework, as well as some practical skills, if he or she is to make sensible recommendations and decisions. This need is heightened when governments are pushing up against the limits of their taxation capacity and when there are limitless demands on the public purse.
This book is an attempt to bridge the gap between financial management and economic management in the public sector. It draws on the disciplines of microeconomics, accounting, public policy (particularly public choice theory), and other disciplines such as game theory and statistics. No prior knowledge of these disciplines is assumed. It does not dwell on the economics of competitive markets, but it does go into some depth on the economics of market failure, where public sector intervention is most likely. It does not go into details of accounting, such as balance sheets and ratio analysis, which are hard to apply in most government agencies, but it does cover basic accrual accounting concepts.
I have tried to give weight to those topics and techniques which are of particular relevance to the public sector and which may be glossed over in economics or accounting units. The theory is generally conventional; the particular contribution of this work is to draw it together and to use spreadsheet modelling as a method of learning.
Structure
This book is in five parts:
1 – Government Budgeting and Accounting
These chapters set the broad theory of government economic and financial management, with emphasis on the Commonwealth Budget and its components. They are both theoretical and illustrative, setting the macro background within which public sector financial management operates, and outlining the theory behind the public sector financial management reforms of recent years. They stress that while many private sector accounting techniques may be applicable to the public sector, their use should proceed judiciously – the public sector is different in many fundamental ways.
2 – Spreadsheet Use and Modeling
This part develops some of the basic analytical and manipulative tools for handling finance. The computer spreadsheet is a powerful analytical tool. At a basic level it can help us do our bookkeeping accurately and efficiently; anyone handling money should be familiar with the spreadsheet as a productivity tool. But beyond that it allows us to develop financial models, which are the key to understanding how financial and economic systems work. Thanks to the spreadsheet, evaluative techniques, such as discounting, Markov modeling, annuity and sinking fund calculations, personnel modeling, and statistical modelling are now no longer the preserve of the high priests of computing, but are available to anyone who has a command of basic high school mathematics.
3 – Benefit-Cost Analysis
These chapters cover theories and practical techniques for choosing between projects. The choice can be as modest as buying a small item of capital equipment, such as an X ray machine or a set of library shelving, up to developing a new high speed rail line. One of the main techniques covered is handling projects and programs in which benefits and costs extend into the future. These techniques include discounted cash flow analysis, sinking fund calculations and others which can be modelled on computer spreadsheets.
4 – Costing and Pricing
Managers need to know costs for many reasons, and in the public sector they increasingly have to set prices, under user pay systems. Sometimes public policy or practicalities will dictate that no price should be set. One chapter covers such situations, providing a discourse on public goods theory. Generally there is conflict between competing objectives of cost recovery, economic efficiency and equity. Ways of regulating supply and setting prices are covered in these chapters.
5 – Non Deterministic Models
Although many planning texts suggest that plans can be made with certainty, this is not generally the case. Uncertainty can arise from strategic situations, where two or more players are engaged in interdependent decision-making. For example, state governments may be engaged in a competitive bidding situation. Uncertainty can arise from forecasting deficiencies, ranging from next year's weather to future commodity prices. It can arise because of minor random events, such as arrivals at a hospital casualty ward. These chapters cover game theory, decision analysis and queuing theory.
Spreadsheet Exercises
An integral aspect of the book is a set of computer spreadsheet exercises in Excel 5/7 format. These are integrated with the text through hyperlinks. Most of these have two parts – a template ("Template") with all data and formatting, but no formulae or calculations, and a completed ("Complete") spreadsheet, which can be referred to for checking.