Wednesday, May 04, 2005
Value for Money-Small Creatures Privatised to the Ground
Source -Mr. Montek Singh Aluwalia, Deputy Chairman, Planning Commission
Narendra Jhaveri, Senior Professor, IIMA
Taken from the working papers of Planning Commission- 22nd December, 2004.
A. The Concept Broadly
In the broadest sense the concept of value for money (VFM) is what the term means in simple English viz, ‘is the society getting value for the tax payers money?’. As the taxpayers money is what finally finances government expenditure and transfers the issue is really one of
(1) The efficacy, and
(2) The efficiency of
of government expenditure. As is obvious there can hardly be efficiency if the expenditure is not correctly directed, or in other words the allocation is not optimal. A completely unconstrained discussion/ analyses of VFM is no less comprehensive that a discussion of state, and the nature of the government, class and the economy.
B. The Concept
Hence in a narrow and meaningful sense VFM assumes that the current state and its political basis is not fundamentally flawed to give adequate value for money. Therefore the focus gets somewhat narrower to
(1) Looking at allocation of government expenditure across sectors and activities
(2) Looking at budget processes and identifying and removing possible dysfuctionalities therein: (Expenditure demands; decision; monitoring; change and auditing).
(3) Asking the question: is not the government’s current expenditure pattern and hence basket of activities such as to be where it has comparative advantage?
(4) Recognizing the limits of governments (organizational and incentive compatible) in enterprise like activities and hence more specifically asking the question of why not the private sector? Why not the private sector in various forms such as unregulated private enterprise (PvE), regulated private enterprise (RPvE) and the private finance initiatives (PFI) ? Or even why not Public Enterprise (PEs) sufficiently distanced from the government and with autonomy over operational and managerial decisions. These questions are particularly important since governments tend to have little variety in the organization forms that they have (for fundamental reasons) and hence enterprise activity is not an area of comparative advantage of government. The question: ‘what form is optimal ?’, has to asked at an activity level rather than at a sector level since newer ways of “unbundling and putting together” have become possible with the developments in contracting and in measurability. The question also needs to posed dynamically since there is the possibility of change in the comparative advantage of governments, and the private sector that includes markets more generally.
(5) Given that many sectors /activities remain natural monopolies (wires business in electricity distribution and transmission for example), the importance of right structuring and managing regulation cannot be overemphasised
C. The Concept Narrowly
Even more narrowly VFM has been discussed in the “project evaluation sense” or even in an (post project) “audit sense”. This has been especially so in the UK, where given an acceptance of privatization/ PFIs etc and light regulation as ways to reach optimal allocation and right structuring, the need for documentation and analysis to argue the case as well for making the choice from among alternatives, and for post facto diagnoses has been important. These requirements have considerably enriched accounting, financial analyses, government audit, regulatory oversight and project evaluation. The difficulties around finding a meaningful public sector comparator should not deter from the major strides made in value for money audit of projects and programmmes.
D. The concept for the Infrastructure
The concept as in C and B above and focused on physical infrastructure would be the domain of 2004.
Given also that the situation in India presents its own features (as an economy that has yet to create its network), the issue in B(4) has to be worked out, and perhaps tempered by the politics (but not by accepting every seeming political constraint). This does not a priori mean a greater role for PEs or for heavy handed regulation. As argued by JR Varma and S.Morris it could actually mean the reverse in such areas as where much of the networks have yet to come.
There are many constraints to efficiency and efficacy of government expenditure that arise even before the issue in B(4) is recognized: lengthy highly gamed dispute settlement process; archaic government accounting processes; dysfunctional politics; confounding effects of subsidy or of inappropriate modes of subsidization; inappropriate design of contracts, bad policy, even perverse restructuring efforts and reform; unacceptance of ‘government failure’ as an idea in discussions; abhorrence or ignorance of markets in the design of projects and policy; entrenched discretionary allocation processes; perverse audit; perverse incentives for public functionaries; deep interference in public (and private) enterprise by ostensibly distanced government; contrary role combinations; inappropriate laws.
In a pragmatic sense for much of the problems as in D(3) the solutions may well lie in the pursuit of privatization/ right regulation, better design and private finance initiatives. So that as a report that points the way forward, per se discussion of the failures /constraints as in D(4) are not of value. [As an example the suggestion that governments should distance themselves from Public Enterprises is not of much practical import since that raises the question: Why has this not happened despite designs and ex-ante pronouncement that PEs would have the autonomy? Or how is one to bring about the same?].
VFM especially should cover (e.g):
Stories of initiatives/ actions by officials and others to improve some public infrastructure; create new infrastructure; reform existing infrastructure
Policy, framework, design, and institutional developments / changes that have much import for VFM both at the level of sectors and more broadly
Privatisation stories; PFI initiatives;
Legal and constitutional changes
Market developments
The Concept Again
The concept necessarily assumes that it is possible to do some measurement of costs and benefits and as such is similar to cost benefit analysis. But there is major difference from the more traditional Cost Benefit analysis (CBA) of the economists; where the object is purely to assess the social costs and benefits given a project. Therein issues of incentive compatibility appropriates of organizational forms including regulation to achieve the project /stream of services; consistency of pricing with the fiscal situation and fiscal process; consistency of prices with dynamic efficiency and efficacy; issues that stem from design but have an impact on management and hence efficiency are all either subsumed or assumed given the ‘public policy’ basis of that approach – i.e. given market failure the state (as being necessarily concerned with the common good) enters. In VFM the recognition of markets is important. While CBA leaves the issue of the large difference between social costs and private costs; and social benefits and private benefits and their second order effects unaddressed, VFM does or ought to recognize these. Thus, CBA would say (because of such difference –and of the social IRR being large) the state or through subsidies the activity is taken up. VFM would or ought to say that when there are large differences (between the social and the private, ie when there are externalities) what (light regulation, PPPs, reduction in transaction costs, design of markets, unbundling, punitive measures, settlement procedures, clearer and more appropriate definition of property rights, liability measures, more general institutional measures) can be done to develop markets to nurture and regulate (them) such that the differences are reduced; and when the differences are fundamental (i.e. when market failure is endemic) then how best can the public sector deliver. Additionally there is (or ought to be) keener recognition of risks (and the asymmetric import or capacity to bear and to reduce them as between the state, private parties, and markets) in VFM.
Conclusion
At most basic level value for money implies returns/benefits exceeding costs. For a precise measure, quantification of costs and benefits is essential. With regard to public expenditure, often benefits are not easily quantifiable. Besides, public expenditure is not always amenable to single goals such as profit maximisation (with regard to private sector also goals are becoming more complex). Although infrastructure, unlike social sector expenditure is more amenable to measurement, simple ratios such as return on investment or economic cost-benefit analysis or for that matter socail cost-benefit analysis are not easy to measure.
Value for money, with regard to infrastructure could best be a descriptive concept built around following four aspects. One is cost. An alternative such as private sector involvement in infrastructure lowers the cost of provision of a given service then it is a movement towards improving the value of money. In this regard, simple comparison between cost with involvement of private sector with a public sector comparator is not always decisive. For instance, if public sector is grossly inefficient in providing a particular service, reduction in this cost will definitely be an improvement but not the LEAST COST OR MOST COST EFFIEICENT ALTERNATIVE. Operations research and other mathematical techniques have been used to determine optimal cost structure in areas where there are no private sector comparators. Theoretically, therefore, one may have to determine optimal cost or least cost solutions and then compare value for money of service being provided with or without private sector involvement. Second aspect is service. Key issue here is budget constraint that is alternative uses for scare capital resources used for a particular service. This remains valid whether a particular service is provided with or without private sector participation. With regard to infrastructure there are two sub elements. One is the level of service to be provided. For instance, if the level is designed top down then it may sometimes result in the level which is well beyond the short-term affordability of the potential users. Outside infrastructure two examples come to mind which will illustrate the issue. For instance, it is well known that Mercedes was an overengineered car, which enabled manufacturers to extort premium when competition was somewhat less intense. During the last few years, one of the thrust areas has been to rationalize engineering without compromising on some of the attributes desired by customers. Second example is the 'bare foot doctor' approach deployed by China to tackle most common ailments by training midwifes and nurses. This might be possibly a relevant aspect in determining, with regard to infrastructure, phased provision of a service. Third aspect relevant to value for money is beneficiaries. While most infrastructure services can be priced as per normal market practices, there could be elements of externality or, almost invariably, need for subsidization for some users, who otherwise could 'vote against' building infrastructure. How to tackle this issue is, relevant for value for money analysis. Finally, there is an aspect of resources. Given that resources are scarce, investment in infrastructure, especially if it involves an element for fiscal or other preference, may crowd out other investments.
The economies should build 'excess capacity' infrastructure as 'supply for infrastructure could create demand', which, in turn, could have significant multiplier and spread effects. The gist of the foregoing is that while it may not be highly productive exercise, as far as the report is concerned, to quantify value for money with great precision but most discussions/contributions could throw some light, depending upon the relevance, and quantify wherever possible, one or more aspects of value for money which come to my mind, though there might be some others.
Extracts of Mr. Jhaveri’s Statement
Closely associated with this concept, and in my view an important aspect is budgetary processes which could help improving value for money from infrastructure. By and large, these would deal with managerially and economically efficient budgetary practices and optimal allocation of resources. Fixation of targets and milestones, their close monitoring and measures to achieve these could form a part of this exercise.
One of the major shortcomings of 'political and bureaucratic' allocation is spreading butter too thinly or riding on too many horses at the same time. Incomplete projects and resultant time and cost overruns are inevitable results of such budgetary practices.
Narendra Jhaveri, Senior Professor, IIMA
Taken from the working papers of Planning Commission- 22nd December, 2004.
A. The Concept Broadly
In the broadest sense the concept of value for money (VFM) is what the term means in simple English viz, ‘is the society getting value for the tax payers money?’. As the taxpayers money is what finally finances government expenditure and transfers the issue is really one of
(1) The efficacy, and
(2) The efficiency of
of government expenditure. As is obvious there can hardly be efficiency if the expenditure is not correctly directed, or in other words the allocation is not optimal. A completely unconstrained discussion/ analyses of VFM is no less comprehensive that a discussion of state, and the nature of the government, class and the economy.
B. The Concept
Hence in a narrow and meaningful sense VFM assumes that the current state and its political basis is not fundamentally flawed to give adequate value for money. Therefore the focus gets somewhat narrower to
(1) Looking at allocation of government expenditure across sectors and activities
(2) Looking at budget processes and identifying and removing possible dysfuctionalities therein: (Expenditure demands; decision; monitoring; change and auditing).
(3) Asking the question: is not the government’s current expenditure pattern and hence basket of activities such as to be where it has comparative advantage?
(4) Recognizing the limits of governments (organizational and incentive compatible) in enterprise like activities and hence more specifically asking the question of why not the private sector? Why not the private sector in various forms such as unregulated private enterprise (PvE), regulated private enterprise (RPvE) and the private finance initiatives (PFI) ? Or even why not Public Enterprise (PEs) sufficiently distanced from the government and with autonomy over operational and managerial decisions. These questions are particularly important since governments tend to have little variety in the organization forms that they have (for fundamental reasons) and hence enterprise activity is not an area of comparative advantage of government. The question: ‘what form is optimal ?’, has to asked at an activity level rather than at a sector level since newer ways of “unbundling and putting together” have become possible with the developments in contracting and in measurability. The question also needs to posed dynamically since there is the possibility of change in the comparative advantage of governments, and the private sector that includes markets more generally.
(5) Given that many sectors /activities remain natural monopolies (wires business in electricity distribution and transmission for example), the importance of right structuring and managing regulation cannot be overemphasised
C. The Concept Narrowly
Even more narrowly VFM has been discussed in the “project evaluation sense” or even in an (post project) “audit sense”. This has been especially so in the UK, where given an acceptance of privatization/ PFIs etc and light regulation as ways to reach optimal allocation and right structuring, the need for documentation and analysis to argue the case as well for making the choice from among alternatives, and for post facto diagnoses has been important. These requirements have considerably enriched accounting, financial analyses, government audit, regulatory oversight and project evaluation. The difficulties around finding a meaningful public sector comparator should not deter from the major strides made in value for money audit of projects and programmmes.
D. The concept for the Infrastructure
The concept as in C and B above and focused on physical infrastructure would be the domain of 2004.
Given also that the situation in India presents its own features (as an economy that has yet to create its network), the issue in B(4) has to be worked out, and perhaps tempered by the politics (but not by accepting every seeming political constraint). This does not a priori mean a greater role for PEs or for heavy handed regulation. As argued by JR Varma and S.Morris it could actually mean the reverse in such areas as where much of the networks have yet to come.
There are many constraints to efficiency and efficacy of government expenditure that arise even before the issue in B(4) is recognized: lengthy highly gamed dispute settlement process; archaic government accounting processes; dysfunctional politics; confounding effects of subsidy or of inappropriate modes of subsidization; inappropriate design of contracts, bad policy, even perverse restructuring efforts and reform; unacceptance of ‘government failure’ as an idea in discussions; abhorrence or ignorance of markets in the design of projects and policy; entrenched discretionary allocation processes; perverse audit; perverse incentives for public functionaries; deep interference in public (and private) enterprise by ostensibly distanced government; contrary role combinations; inappropriate laws.
In a pragmatic sense for much of the problems as in D(3) the solutions may well lie in the pursuit of privatization/ right regulation, better design and private finance initiatives. So that as a report that points the way forward, per se discussion of the failures /constraints as in D(4) are not of value. [As an example the suggestion that governments should distance themselves from Public Enterprises is not of much practical import since that raises the question: Why has this not happened despite designs and ex-ante pronouncement that PEs would have the autonomy? Or how is one to bring about the same?].
VFM especially should cover (e.g):
Stories of initiatives/ actions by officials and others to improve some public infrastructure; create new infrastructure; reform existing infrastructure
Policy, framework, design, and institutional developments / changes that have much import for VFM both at the level of sectors and more broadly
Privatisation stories; PFI initiatives;
Legal and constitutional changes
Market developments
The Concept Again
The concept necessarily assumes that it is possible to do some measurement of costs and benefits and as such is similar to cost benefit analysis. But there is major difference from the more traditional Cost Benefit analysis (CBA) of the economists; where the object is purely to assess the social costs and benefits given a project. Therein issues of incentive compatibility appropriates of organizational forms including regulation to achieve the project /stream of services; consistency of pricing with the fiscal situation and fiscal process; consistency of prices with dynamic efficiency and efficacy; issues that stem from design but have an impact on management and hence efficiency are all either subsumed or assumed given the ‘public policy’ basis of that approach – i.e. given market failure the state (as being necessarily concerned with the common good) enters. In VFM the recognition of markets is important. While CBA leaves the issue of the large difference between social costs and private costs; and social benefits and private benefits and their second order effects unaddressed, VFM does or ought to recognize these. Thus, CBA would say (because of such difference –and of the social IRR being large) the state or through subsidies the activity is taken up. VFM would or ought to say that when there are large differences (between the social and the private, ie when there are externalities) what (light regulation, PPPs, reduction in transaction costs, design of markets, unbundling, punitive measures, settlement procedures, clearer and more appropriate definition of property rights, liability measures, more general institutional measures) can be done to develop markets to nurture and regulate (them) such that the differences are reduced; and when the differences are fundamental (i.e. when market failure is endemic) then how best can the public sector deliver. Additionally there is (or ought to be) keener recognition of risks (and the asymmetric import or capacity to bear and to reduce them as between the state, private parties, and markets) in VFM.
Conclusion
At most basic level value for money implies returns/benefits exceeding costs. For a precise measure, quantification of costs and benefits is essential. With regard to public expenditure, often benefits are not easily quantifiable. Besides, public expenditure is not always amenable to single goals such as profit maximisation (with regard to private sector also goals are becoming more complex). Although infrastructure, unlike social sector expenditure is more amenable to measurement, simple ratios such as return on investment or economic cost-benefit analysis or for that matter socail cost-benefit analysis are not easy to measure.
Value for money, with regard to infrastructure could best be a descriptive concept built around following four aspects. One is cost. An alternative such as private sector involvement in infrastructure lowers the cost of provision of a given service then it is a movement towards improving the value of money. In this regard, simple comparison between cost with involvement of private sector with a public sector comparator is not always decisive. For instance, if public sector is grossly inefficient in providing a particular service, reduction in this cost will definitely be an improvement but not the LEAST COST OR MOST COST EFFIEICENT ALTERNATIVE. Operations research and other mathematical techniques have been used to determine optimal cost structure in areas where there are no private sector comparators. Theoretically, therefore, one may have to determine optimal cost or least cost solutions and then compare value for money of service being provided with or without private sector involvement. Second aspect is service. Key issue here is budget constraint that is alternative uses for scare capital resources used for a particular service. This remains valid whether a particular service is provided with or without private sector participation. With regard to infrastructure there are two sub elements. One is the level of service to be provided. For instance, if the level is designed top down then it may sometimes result in the level which is well beyond the short-term affordability of the potential users. Outside infrastructure two examples come to mind which will illustrate the issue. For instance, it is well known that Mercedes was an overengineered car, which enabled manufacturers to extort premium when competition was somewhat less intense. During the last few years, one of the thrust areas has been to rationalize engineering without compromising on some of the attributes desired by customers. Second example is the 'bare foot doctor' approach deployed by China to tackle most common ailments by training midwifes and nurses. This might be possibly a relevant aspect in determining, with regard to infrastructure, phased provision of a service. Third aspect relevant to value for money is beneficiaries. While most infrastructure services can be priced as per normal market practices, there could be elements of externality or, almost invariably, need for subsidization for some users, who otherwise could 'vote against' building infrastructure. How to tackle this issue is, relevant for value for money analysis. Finally, there is an aspect of resources. Given that resources are scarce, investment in infrastructure, especially if it involves an element for fiscal or other preference, may crowd out other investments.
The economies should build 'excess capacity' infrastructure as 'supply for infrastructure could create demand', which, in turn, could have significant multiplier and spread effects. The gist of the foregoing is that while it may not be highly productive exercise, as far as the report is concerned, to quantify value for money with great precision but most discussions/contributions could throw some light, depending upon the relevance, and quantify wherever possible, one or more aspects of value for money which come to my mind, though there might be some others.
Extracts of Mr. Jhaveri’s Statement
Closely associated with this concept, and in my view an important aspect is budgetary processes which could help improving value for money from infrastructure. By and large, these would deal with managerially and economically efficient budgetary practices and optimal allocation of resources. Fixation of targets and milestones, their close monitoring and measures to achieve these could form a part of this exercise.
One of the major shortcomings of 'political and bureaucratic' allocation is spreading butter too thinly or riding on too many horses at the same time. Incomplete projects and resultant time and cost overruns are inevitable results of such budgetary practices.
