The Wonder Down Under

ith more than 12,000 employees, New Zealand's Ministry of Public Works used to be one of the country's largest departments. The 125-year-old ministry built most of the island nation's infrastructure-its airports, bridges, power stations, roads, canals, dams and railways. Functions ranging from maintaining military bases to land use planning were also under the ministry's auspices.

Now it no longer exists.

In 1990, the ministry was split up. All policy advice functions were transferred to other departments. Commercially oriented agencies-property services, computer services, architectural and engineering consulting, construction and maintenance and road sign production-were converted into state-owned enterprises (SOEs) and reorganized along business lines. Each was required to pay taxes, raise capital on the market (with no government backing-explicit or implicit) and operate according to commercial principles. At the same time, the SOEs were freed from civil service, procurement and financial management regulations.

Over time, each of the new SOEs were sold to the private sector. New Zealand no longer has any government in-house capability to design, build or repair infrastructure. When these services are needed, they are purchased on the open market.

Dramatic changes like these have occurred across New Zealand's state sector during the previous dozen years, rendering New Zealand's present government unrecognizable from what it was only a decade ago. To be sure, revolutionizing government in a country that has only 3.5 million people, a unicameral legislature and a parliamentary system is much easier than in the United States, where we have considerably more checks and balances-not to mention people. Nevertheless, the fact that cutting-edge public sector reforms of the New Zealand variety have also been undertaken to various degrees in Australia, Canada and Great Britain means that they are likely to soon reach American shores.

Far-Reaching Reform

New Zealand's public sector reforms are considered more comprehensive and far-reaching than have occurred anywhere in the world for decades.

Since 1988, more than two dozen state enterprises have been sold off, including railroads, ports, telecommunications operations, banks, public works and even commercial forests. More than $14 billion (in New Zealand dollars) in revenue-about 26 percent of New Zealand's GDP-was achieved through the sales. An equivalent asset sale program in the United States would realize more than $1 trillion.

In addition, more than a dozen key enterprises-including the postal service, air traffic control and weather service-have been transformed into SOEs and now are considered among the best-run in the world in their sectors.

New Zealand reformers have also revolutionized the systems and structures of government. Through the introduction of cutting-edge management and organizational reforms-purchaser/provider separation, output-based budgeting, performance contracts, purchase agreements and increased managerial flexibility-what's left of the New Zealand state sector costs less and delivers better services.

It is no surprise, then, that New Zealand has acquired a growing reputation for representing the vanguard of public sector reform. In David Osborne's new book, Banishing Bureaucracy (Addison Wesley), New Zealand gets its own, glowing chapter. Allen Schick of the Brookings Institution in Washington, an expert on comparative political systems, has said that New Zealand alone "has transformed the public sector so boldly and comprehensively."

But not only academics and policy wonks are paying attention to New Zealand. So many governments have sent delegations to the country that it is said that government reform is the country's best tourism draw.

Congressman Scott Klug, R-Wis., the GOP's point man on federal privatization, led one of these delegations last summer. After suffering political setbacks on federal privatization in the last session of Congress, Klug (along with Dana Rohrabacher, R-Calif., and Bill Orton, D-Utah) journeyed to New Zealand to learn how the Kiwis were able to privatize so much, so quickly. "Anyone who looks at privatization and government reform trends around the world tends to look first at New Zealand," says Klug. "No one has done a better job than them."

New Zealand's state-owned enterprise model is being studied by Republicans-and some Democrats-who are searching for a transitional structure for federal enterprises being prepared for privatization. "We're trying to come up with a uniform process for the transition to privatization so we don't have to go through the fighting each time," explains Mark Brasher, a staffer on the House Government Reform and Oversight Subcommittee on Government Management, Information and Technology.

There is also interest at the National Performance Review. "They have done a remarkable job," says John Kamensky, the NPR's deputy project director. "Our goal is to manage for results. There clearly are aspects of the New Zealand model that can help us to get to where we want to be."

Given such enthusiastic bipartisan interest, the reforms merit a closer look.

The SOE Model

One of New Zealand's first reforms was to separate out all of the government's commercial activities from line ministries and convert them into free-standing state-owned enterprises.

A private sector board of directors was recruited for each of the new SOEs-more than 200 private businessmen and women were recruited to serve on the boards. They were charged with ensuring that the enterprises operate in accordance with commercial principles.

One of the new SOEs was established by drawing a clear distinction between natural forests and commercial forests. A Department of Conservation was created and charged with protecting the natural forests, while the remaining commercial forests formed the core of the new Forestry Corp. The commercial forests were renamed "wood plantations." The Forestry Corp.'s purpose was to earn a profit by farming wood as a crop.

This separation clarified the government's previously muddled objectives in managing forests. "We got away from mixed use objectives and the problems associated with that," says Ken Shirley, one of Forestry's board members. "We figured out that it was only through intensive wood farming that we could offer protection to our remaining natural forests."

The chairman of the Forestry Corp.'s board was Alan Gibbs, a wealthy and aggressive Kiwi businessman. Gibbs quickly set about making the Forestry Corp. a profitable company. Generous severance packages helped reduce the agency's bloated workforce dramatically, from 7,000 to 1,150 employees. Gibbs then signed up most of the remaining employees on individual employment contracts.

As has been the case with many of New Zealand's SOEs, the Forestry Corp. was subsequently privatized. "After the separation, the logic for government to own and manage the commercial forests wasn't there," says Shirley. "Government doesn't run dairy farms or kiwi fruit farms, so why should it run wood farms?" The sale occurred in three stages over a 10-year period ending in August of last year. It brought in $1.2 billion.

The Forestry Corp. sale did not occur without opposition. Opponents were appalled that the government would sell off state-owned forests-regardless of whether they were commercial or not. The environmental community has organized an active signature drive and lobbying campaign to buy back the forests.

Privatizing Public Works

The same day in August 1996 that the New Zealand Herald announced the sale of the final part of the Forestry Corp., it reported the sale of two other Kiwi SOEs: Works Consultancy Services, which provides design and engineering services, and Works Civil Construction, the country's largest infrastructure builder. The SOEs constituted the last vestiges of New Zealand's once massive Ministry of Public Works. The sales yielded another $99 million.

John Rutledge, the chief executive of Works Consultancy, took over the enterprise in 1988, soon after it was split apart from Works Civil and transformed into a free-standing SOE. "At the time, splitting the design and construction was quite controversial," says Rutledge. "There was lots of debate whether to keep them together or split them."

The deciding vote came from Transit New Zealand, the government's "purchaser" of infrastructure services. Transit New Zealand didn't want Works Consultancy and Works Civil to stay together on the grounds the combined group would represent unfair competition with private competitors. "[Transit New Zealand] wanted us to behave exactly the same as any other consultant in New Zealand," says Rutledge.

Eighteen months before Works Consultancy was incorporated, all its work was opened up to competitive bids from private firms. Transit New Zealand quickly became a very discriminating consumer, showing no reluctance about choosing private companies over Works Civil and Works Consultancy. "At the time, private firms thought we would be so inefficient that we would fall over in two years," remembers Rutledge.

This didn't happen. Competition forced Works Consultancy to go to great pains to retain and expand its client base-including foregoing any loyalty they had to their former colleagues at Works Civil. "We looked at who we thought we were most likely to win the job with," says Rutledge. "Often we put in bids with Works Civil Construction's biggest competitors."

Once the New Zealand government could obtain engineering and construction services by purchasing them on the market, the case for actually owning Works Consulting and Works Civil was no longer there. Both were prepared for sale. By this time Works Consultancy had been operating successfully in the marketplace for several years without subsidy. This softened internal resistance to the sale. "The staff had built up considerable confidence in our ability to perform in the market so we weren't as concerned as we would have been five years ago, before we tested our feet in the market," says Rutledge.

Purchaser/Provider Split

The key reform turning New Zealand's government from a provider of engineering and construction services into a purchaser of these services is the "purchaser/provider split." Across the public sector, New Zealand has separated policy advice, service delivery and regulatory activities.

The rationale for this uncoupling is to prevent "agency capture," a term used to describe the situation when an agency's policy advice is "captured" by the service delivery department for the purposes of recommending itself as service provider and biasing policy advice toward increased spending. As was demonstrated by Transit New Zealand's willingness to purchase services from private companies instead of state enterprises, separating the purchaser and the provider provides powerful incentives for policy agencies to be more independent and demanding purchasers.

The separation is also meant to reduce the conflicting objectives that arise when the same agency is involved in service delivery and regulation. For example, in the United States, the Federal Aviation Administration regulates airline safety at the same time it is charged with promoting low-price airline travel. In New Zealand, agencies regulating transportation industries-airlines, railroads, trucking and road safety-have been split off from the Transport Ministry into separate independent entities and put under private sector boards of directors. Regulatory outputs are now "purchased" from each agency by the country's Transport Minister.

The purchaser/provider split works best when there is real competition between suppliers and the government has no incentive to give preference to public entities.

One split that hasn't worked so well occurred in New Zealand's Defense Department. In the early 1990s, defense policy was separated out from military operations to break the military's monopoly on defense policy advice.

In practice, however, the separation achieved neither a reduction in military influence on defense policy nor any real competition in policy advice, argues Jonathon Boston, a professor at Victoria University in Wellington, New Zealand. Instead, the result was duplication of functions and more tension in the defense policy community. "Decoupling appears to have worked better in some areas than others," says Boston. "In the defense area, it has been of questionable merit." Boston says foreign affairs, intelligence and policing are other areas where decoupling may be inappropriate.

Freedom to Manage

In the United States, many a hard-driving executive has plunged bravely into battle to dramatically streamline a government agency and . . . retreated. Frustrated by a wall of civil service and legislative restrictions that stymie their ability to manage, they raise the white flag, either by leaving the public sector or staying and resigning themselves to the status quo.

John Lumsden, the chief executive of MetService, New Zealand's weather forecasting SOE, had a different experience when he was hired away from Labatt's Breweries in Canada in 1992 to turn around the weather organization, which had overspent its budget by $2 million. "I wouldn't have taken the job if I had to abide by all the silly rules and bureaucracy that used to exist here in the public sector," explains Lumsden from his hilltop office in Wellington with a view of the city's picturesque bay.

No other government meteorological service had ever been incorporated, so Lumsden was without a model. Undaunted, he went about restructuring the organization as if it were a private company. Poor performers were asked to find new work. Lower skilled jobs were cleaned out. Staffing was reduced from a peak of 360 in 1988 to 160. (Many of these employees were transferred to a science research institute.)

But MetService's turnaround was more than just an exercise in cost-cutting. While payroll costs fell, individual remuneration went up. MetService's highest skilled meteorologists received pay raises so they wouldn't jump ship to the private sector. Most of the employees were put on performance contracts.

Lumsden also initiated profit-sharing. The notion that the pursuit of profit was now central to MetService's mission required a major culture change in an organization where many of the employees had never even worked in the private sector. "I had to do a lot of work convincing people that profitability was a good way to judge our success," recalls Lumsden. "They tried to change our mission statement to being 'successful,' but I hung tough. I would not let go of the notion that profitability was what we were about."

Lumsden's persistence paid off. In 1992, MetService supplied no forecasts to local newspapers; it now has 75 percent of New Zealand's newspaper market. Moreover, it has also broken into Australia's market, supplying Sydney's Daily Telegraph Mirror (which has a circulation of 1.3 million) and three other Aussie papers.

Last year, for the first time ever, MetService earned a profit. Each employee took home an extra $3,000, thanks to Lumsden's profit-sharing plan.

Extending Reforms

The dramatic successes that emerged from the creation of SOEs prompted the New Zealand government to extend the notion of managerial flexibility and accountability to the core public sector.

In 1988, chief executives in every state agency now have the power to hire, fire, pay, promote, reduce (or eliminate) job classifications and negotiate collective bargaining contracts. Control over procurement and financial management have also been devolved down to the agencies.

The bargaining relationship, which used to be based almost exclusively on collective bargaining, now blends individual and collective employment contracts and private contractors and consultants. In some agencies-the Treasury Department and the State Services Commission, to name two-nearly all the employees have opted for individual, performance-based contracts.

These reforms were critical. "Control over human resources was the key," says Rob Laking, the former chief executive of the country's Housing Policy Unit. "You're not walking the talk unless you have charge over your people."

George Hikton, an executive from Honda Motors, found this out when he was hired to overhaul the Income Support Services division of New Zealand's Department of Social Welfare. The agency, which determines an applicant's eligibility for welfare payments, had a well-deserved reputation for incompetence and poor service.

With Hikton at the helm, the agency's walls came down-both figuratively and literally. In every field office, the walls separating the case managers from the clients were torn down. Several layers of management were eliminated. Managers were placed on individual performance-based contracts. And drawing on models developed by the retail clothing industry, competition between district offices was encouraged through the daily ranking of offices on quality and efficiency. Soon the time to process an application had fallen from 24 days to overnight.

Now, the Wellington district office of Income Support Services is headed by Nigel Bickle, a young man with a carefully groomed goatee and a diamond earring. He is 26. And he is an exceptional manager.

Prior to the reforms, it would have taken at least a decade for someone like Bickle to rise to a district manager's job. Chances are, frustrated with the painfully slow uphill climb, he would have left for greener pastures in the private sector.

"Initially there was quite a lot of talk along the lines of 'whose butt have you been kissing?' and 'You haven't been here for 10 years,' " recalls Bickle. "But things were changing quickly. Structures were becoming flatter. There was an environment of recognizing people that did perform."

Of course, not everyone has come out a winner in the reform process. Devolving industrial relations to chief executives, in combination with the purchaser/provider split-which created smaller, more numerous and more independent agencies-has made life more difficult for unions. New Zealand's principal public employees' union now negotiates more than 300 separate collective contracts, compared to only a handful before the reforms.

"The reforms took the ground out from under their [the unions'] feet," says one former chief executive. "They had to fight on more fronts." Public employee membership has fallen by 13 percent since 1991, at the same time it has risen in most other western industrialized countries.

Despite the adverse consequences for public unions, there has been remarkably little industrial strife in New Zealand. One explanation: The government moved so fast that the unions never knew what hit them. "The public unions didn't feature in a big way in blocking the reforms," recalls one former Treasury official. "They didn't seem to realize what was going on."

Making Managers Accountable

There is more to reform than transferring power away from central agencies and unions to agency managers.

It is typically much easier for central agencies to give up control than to enforce strict accountability for department managers. New Zealand alone, say experts like Brookings' Allen Schick, has established a rigorous regime that holds managers accountable for their agency's performance.

New Zealand's chief accountability tool is the contract. Written contracts between ministers and chief executives are relied upon for allocating resources, maintaining accountability, specifying organizational responsibilities and delivering services. The goal is to replicate the arms-length relationship between buyers and sellers found in competitive markets.

The contract approach is also designed to force state bureaucracies to respond to political direction. Before the reforms, one minister likened trying to get the bureaucracies to do something to "pulling on a lever not attached to anything."

One of the contracts is the fixed-term, performance-based agreement worked out between each chief executive and the minister who oversees his or her operation. The agreement contains a list of items the minister and the executive believe are the agency's most important goals for the year. Typically, at least 10 percent to15 percent of each executive's salary is at risk, depending on performance. Bonuses of up to 20 percent can be earned for superior performance. "Having clarity of performance expectations is key to a good accountability system," says a senior Treasury official, adding that the agreements focus executives on exactly what is expected of them.

Chief executives, in turn, typically require performance agreements from their senior managers, who do the same for those working under them. "You can take the performance agreements and cascade them through the organization," explains Roger Blakely, chief executive of the Ministry of Internal Affairs.

The End of Pork Barreling

Coupled with the performance agreements are purchase agreements. These specify the quality, quantity, price and delivery deadline of each output the chief executive is to supply to the government. This allows ministers to decide which outputs to purchase for the year and, when possible, to select the best supplier on a competitive model.

The outputs are priced in a manner similar to market transactions: Ministers negotiate a price for outputs based on the goods and services supplied-in theory irrespective of input costs. For example: the Minister of Justice might negotiate with the Correctional Services Agency to house a certain number of prisoners at a certain price and with the police for an amount on crime prevention programs.

The system works best when ministers are active, interested purchasers of services. One former Finance Minister would literally rip out pages of budget requests when she didn't want to "buy" the recommended outputs. Gone were all the inputs that went into delivering those outputs.

Lobbyists use to line up outside New Zealand Cabinet meetings to wait for their opportunity to ply ministers for special privileges. This doesn't happen anymore. Purchase agreements and output-based budgeting have done away with pork barrel spending. Because the chief executives have complete control over the mix of inputs they use to produce outputs, from road construction to science spending, the mix of projects funded is determined solely on a cost-benefit analysis by the relevant agencies. "With our system, there is no political interference on where the money goes for roads," says Stuart Milne, the chief executive of the Ministry of Transport.

"I couldn't imagine having people coming through this office all day lobbying for special favors," says Simon Upton, a member of Parliament. "Our new system is a good security against corruption in politics."

Undoubtedly there are some real costs to New Zealand's contract model of governance. Writing, monitoring, evaluating and enforcing the performance agreements, purchase agreements and other contracts entails substantial transaction costs. Separating policy and service delivery can make policy coordination trickier. And lastly, elected officials have less direct influence on internal agency operations.

The end result, say some critics, is the loss of the trust, flexibility and accountability required to run government in a democracy. "The more we fragment the structure of government by replacing command hierarchies with networks of contracts, the more we call in question the nature of responsible government by attenuating the responsibility of elected representatives," writes Victoria University professor John Martin in a critique of the contract model.

But most academics and senior New Zealand government executives argue that the costs of the New Zealand model are well worth the substantial gains in efficiency and accountability. "Any relationship is informed by being specific about some things," says a Treasury official. "If anything, our system is not nearly detailed enough; it isn't even close to that which exists in the private sector."

'You Guys Are Crazy'

Much of the Clinton Administration's second-term government reform efforts will center on pushing the concept of performance-based organizations (PBOs). While modeled after Britain's Next Steps program, the PBO model is very similar to New Zealand's business units. Run by chief executives on fixed-term performance contracts, PBOs would be given flexibility in procurement and greater control over personnel and financial management.

When legislation for the first PBO candidate, the Patent and Trademark Office, was sent to Congress, it aroused a debate between the administration and Rep. Carlos Moorhead, R-Calif., then chair of the House Judiciary subcommittee on courts and intellectual property, regarding the relative merits of the PBO model versus a corporation or SOE model. This debate is likely to be replayed for future PBO candidates.

In this regard, the New Zealand experience is instructive. Agencies such as Income Support Services have been converted into the equivalent of PBOs, with chief executives who have broad managerial freedoms. Improvements have occurred, but in a much less dramatic fashion than in the SOEs. "Measured against the cultural upheaval in the state-owned enterprises, change in most departments has been significant but not revolutionary," writes Allen Schick in a study of New Zealand's reforms.

Two major factors explain the difference in performance. First, politicians have generally kept their hands out of the operation of the SOEs, giving chief executives the freedom to manage the enterprises. Second, the requirement that the SOEs pay taxes and raise capital on the market provides strong financial discipline of the enterprises.

Nevertheless, the NPR's Kamensky doesn't see much likelihood of extensive use of the SOE model in the United States. "Our PBO model is considered very radical," he explains. "If we tried to jump to the SOE model, they would say 'You guys are crazy.' "

A major political roadblock to the SOE model is also its strength: It removes political interference from enterprise operation. "PBOs have been selected on the basis that they're government functions that shouldn't be privatized," says John Koskinen, deputy director for management at the Office of Management and Budget. "Spinning them off into SOEs would only create more problems with accountability and control."

Kamensky sees better short-term prospects for replicating New Zealand's use of contracts to hold departments accountable for results. "A performance-based, contractual approach is something we will be clearly moving towards, dangling the prospect of more freedom for managers with holding them contractually accountable for outcomes," says Kamensky.

Though encouraged by such statements, Wisconsin Rep. Scott Klug is decidedly underwhelmed by the PBO concept. "We're not going to balance the budget by tinkering with organizational flow charts," says Klug. "We need to ask the more fundamental questions of what is the federal government doing now that it shouldn't be doing, and how can we get the government out of those areas?"

Klug believes that once politicians realize that balancing the budget could require unpopular measures such as cutting student loans, then selling federal labs or privatizing the Energy Department's Power Marketing administrations will become more politically palatable. "My most memorable moment in New Zealand was visiting the Postal Corporation and reading a sign that said 'If you're not living on the edge, you're taking up too much room,' " recalls Klug. "The real goal should be to privatize or eliminate programs that we've been doing for 40 to 60 years that we don't need to do anymore."

While U.S. politicians and administration officials may debate the feasibility and desirability of the finer points of some of New Zealand's reforms, few Kiwi government executives seem to want to go back to the old way of doing business. In fact, some express a desire to go even further.

MetService's John Lumsden wants to expand into new markets overseas and offer new real-time information products. But he feels restrained by his owner, the New Zealand government. "As we get more and more successful in overseas markets, we get further and further away from our core mission," says Lumsden. "This understandably creates discomfort for the government in its role as owner."

"I hope [we] will be sold," says Lumsden. "It would give us more flexibility for international developments and provide the capital we need to pursue new products and markets."

In the United States, it is hard to imagine a federal agency head agitating for the government to sell his or her agency. But, just maybe-if the New Zealand experience is any guide-a couple years operating as a government enterprise in the marketplace could cause some to change their tune.