How governments add value

In both Australia and the US, we are in the midst of election fever - we have to choose between Turnbull and Shorten here and in the US, it is likely to be Clinton vs Trump. Until early July (or November if you're in the US) we will be bombarded with political rhetoric and "analysis".

Seldom though is the dialogue framed in terms of how well governments deliver value for their economies.  This is a shame.  If we avoid thinking about this issue, we effectively sleep walk into the future by just doing what we did yesterday. If we continue to do this, we miss the opportunity to revitalise the role of governments in our economic systems.

Where governments have a competitive advantage

Value is created when businesses compete where they have an advantage.  In my view, governments have a competitive (possibly even an absolute one) advantage over any business in the following three roles:

• Managing externalities (particularly negative ones): Externalities are a side effect to a transaction that affects others than the transaction participants. Generally speaking, markets are awesome at sorting out value when externalities are minimal, but have difficulty when externalities are significant - this is most dramatically described as "market failure". At a micro level, externalities might be the late night noise from a party next door or at a macro level, the environmental damage from commercial activities. Governments can manage this issues by effective regulation or policing, taxation strategy or by social policies that encourage acknowledgement of (and more importantly, respect for) the impact of your own actions on others.
• Reducing transaction costs in markets: Transaction costs reduce trade, and as a result reduce the value that the economies develop from that trading. Transaction costs can include a lack of trust, one-sided information, taxes that inhibit transfers of assets to the owner who values them the most, administrative burdens and monopolistic pricing. Governments can reduce transaction costs by developing title and contract law, implementing transparency initiatives, opening markets, designing/executing sensible regulation and reforming tax policy.
• Provision of "public goods": Public goods are things that we can all enjoy at the same time, and my enjoyment of it doesn’t affect yours. Great examples are the wonderful National Parks that surround my home, Sydney, but equally relevant are social cohesion, national security and an effective justice system. The tricky thing about public goods is that it is hard to charge for them, so private provision of them is mostly impractical. This is where governments operate many of their businesses rather than influencing the behaviour of other market participants.

These roles are very difficult for any organization to carry out, unless they are a government.

These roles suggest that the scope of government should extend mostly to where they have a competitive advantage, which seems to me to make sense.  On the other hand, I have difficulty accepting an argument which holds that governments should act in roles where they do not have an advantage (basically we are all worse off if they do). Conversely, the minimalist government proposed by the Chicago school can at times sell short a government’s competitive advantage over the private sector in certain roles.

So it is pretty clear that governments can and do add value. But we can be equally sure that we have plenty of experience when things don't work so smoothly. This begs the question:

What stops governments adding value?

A few things come to mind:

• Governments act in their own interest: This paper talks about how government, when trying to act in the interests of its population, may not add value. A worse problem happens when Governments act in their own interest and not the population's; think kleptocratic governments that channel aid into the coffers of their leaders, corrupt ones that extort their people, and barbarous ones that carry out destructive polices to preserve power at the expense of economic well-being. I am pretty hopeful that we don’t have this problem to a great extent in our three levels of government here, but these problems can exist and destroy value when they do.
• Ideology beats out pragmatism: at its best, economics is a pragmatic art. Its focus should what works, and how can it be better, not necessarily how it should work. It is also dynamic, evolving to deal with changes in circumstances. However, ideology argues a fixed and overarching view of how things should work. This sort of thinking creeps into to economic argument though all the time; for example: "privatisation is always good (or bad for that matter)", "the market always is best" or "capitalism is evil". Any reasonable person will tell you that sometimes these ideas work, and sometimes they don't. A focus on ideology over evidence-based experimentation and adjustment lets us all down.
• Illusion of control: the illusion of control, imported from behavioural economics, is a powerful enemy of value. It causes us to think that governments can influence or even control things which are out of their control. This can result in us blaming governments things that aren't their fault, and moreover can cause them to intervene when they have no control at all, just to counter this perception. This costs every taxpayer with no net benefit to the community. Sounds dumb and it is, even though the spell of this powerful illusion is difficult for us to ward off even in our own lives.
• Interest groups gain disproportionate influence: often the economic benefits of change are widely spread, but the costs are borne by a small group. If the costs are large enough for the small group, and they are well organised, this can stymie change, even if that change is overwhelmingly positive for the economy as a whole.
• Risk aversion: often times the government and its servants can seem like football referees; when all goes well you don't notice them and when things go awry (let's face it, we all make mistakes) they are roundly criticised. Over time, this can provide an incentive to take less risk, leading to less than optimal outcomes. It can also lead to an over investment in risk management procedures, policy and processes, a problem that increases the budgets and delays reaction speeds of government operations worldwide. This must be frustrating and difficult for those trying to provide good public service, but it costs all of us too.
• Psychological biases rule the roost: the operation of government is so bewilderingly complex, with so many dimensions; it often takes more energy than most have on offer to understand it. This causes information overload, with many withdrawing their interest, or using cognitive short cuts ("he's got Kennedy hair so he must be a good leader") to make complex decisions which might affect their interests. We can help people by using straightforward language to discuss economic and other politically relevant concepts to reduce this burden and help society make collectively better decisions.
• Slow and imperfect feedback loops: feedback is one of the most powerful weapons for improving outcomes. Just as children learn to walk by falling over, businesses learn from customer feedback, particularly when they stop buying products. The more direct and timely, the more effective this feedback is. In government, the feedback is filtered through a political process, effects different stakeholders in different ways and often price and demand signals (the most direct of all feedback) are not available at all. This means that feedback can be costly, slow, indirect and sometimes plain misleading. This slow feedback can mean that programs continue for longer than they might if feedback were more prompt – leading to resources being wasted.
• It’s all a bundle: When you are a citizen, you generally pay ad valorem taxes on income or consumption and receive a package or bundle of benefits from the government. Anyone who has bought a bundle of pay TV knows the challenges when you want Discovery channel but you can only buy it in a package with Nickelodeon – and you don’t have kids!  Government faces many of these types of choices; elected candidates come with a package of positions and you can’t separate the ones you like from the others.
• What's important doesn't always get measured: the most constantly referred to statistic in economics is gross domestic product or GDP. This measures the financial output of the economy in the most easily understood way - dollars and cents. Whilst a useful measure in many respects, GDP doesn't measure everything that is going on in an economy. For example, in the private sector, it doesn't capture much of our domestic or voluntary activity, and in the public sector, almost none of the items outlined at the start of this article in are captured at their full value. If we ask governments to focus purely on what is measurable easily, which is very tempting to be sure, we could inadvertently sell ourselves down the river.

Now these problems don’t just occur in governments; variations on these themes happen in many large organisations.  However, the complexity and breadth of government’s role means that they occur more often. 

The existence of both the competitive advantages of governments and an understanding of their structural challenges is important.  This understanding provides a framework through which to judge where to set the boundaries of government and also provides a yardstick to assess the value that they add within the boundaries. 

To my mind, viewing government policy through this value lens (particularly value for ordinary citizens) would be a step forward from what can pass for political discourse most days.

Using this thinking in the upcoming elections

 The media will be full of news of elections and politics in the months to come.

Hopefully, this article sets out a way to test policy proposals about how they might add to our overall well-being.  It also provides a checklist of things to watch out for that might compromise the intent of what is proposed.

Of course, what we end up with is a tradeoff of some of the risks outlined above with some of the benefits that good government provides.  That’s only natural.  But if we don’t critically assess this process, we have no hope of making a better choice – this article provides at least some of the concepts that help this critical assessment.

-----------------------------------------------------------------------------------------------Richard Stewart OAM is a Corporate Value Advisory partner with PwC.  He has been with them for 30 years in Australia, Europe and the USA, doing his first valuation in 1992. He has helped his clients achieve great outcomes using his value skills in the context of major decisions, M&A, disputes and regulatory matters.  His clients span both the globe and the industry spectrum.  He holds a BEc, MBA, FCA, FCPA, SFFin, FAICD and is an accredited Business Valuation Specialist with CAANZ.  He has written a book, Strategic Value, published in 2012, and is an Adjunct Professor at UTS. He also was PwC’s federal Government leader for 4 years during the mid 2000s.