Performance Measurement In The Public Sector Finance Essay

Performance Measurement In The Public Sector Finance Essay In recent years governments within Canada have been facing increased pressure from the public to be more financially accountable, transparent and responsible when it comes to managing tax dollars. In large part, this is due to several economic and social pressures, such as an aging population, budgetary deficits and various financial scandals, which make the need for effective and efficient financial management a pressing matter. Governments have been developing systems, approaches and processes to continually ensure value for money, including integrating private sector practices into the public sector (e.g. New Public Management and Public Sector Renewal). One such private sector practice is the extensive use of and reliance on performance measures, which are used to obtain information thought to be critical to ensuring effective and efficient financial management, such as tracking government debt, program success, and forecasting future programming needs. This paper will demonstrate and explore the theory of performance measurement, including its advantages and disadvantages. A case study will then be presented, which will outline, apply, and assess financial performance measures used by the Ontario government on its provincial budget covering the period from 2002 to 2007. The paper will then conclude with observations and recommendations for more effective use of performance measures and a better understanding of the benefits and, perhaps more importantly, the limitations of performance measurement. Performance measures, while a useful tool, are not sufficient to guarantee effective and efficient management of public resources. Context for the need for performance measure in the public sector Governments are increasingly grappling with complex social and economic pressures. For instance, the aging of the population is expected to have important impacts on governments revenues and expenditures. With soaring health care costs as the population ages, Roy Romanow (2002) in his report on the future of health care in Canada estimates that annual per capita expenditure on people aged 65 and over is three times as much as the average of all age group spending (p.57). Looking at Ontarios annual report and consolidated financial statements between 2002 and 2007, the province has seen a significant increase in its expenditure in health and long term care where the province increased its expenditure by approximately 9.9 billion dollars or a 36.8 percent spending increase over five years. Overall expenditures during the same time period have increased by 20.4 billion dollars or a 28.6% increase. This essentially means that approximately 49% of the increase in expenditure went to health care spending. Ontarios revenues on the other hand increased by 21.8 billion dollars or a 31.8% increase. However, net debt has increased by 8.5 billion dollars or a 6% increase (Please refer to appendix 1.1). As these statistics show, expenditures on health care represent a significant proportion of provincial spending, a situation that may be exacerbated by an aging population. Furthermore, Saks and Haccoun (2004) estimates that Canadian labour supply shortage will reach the one million plateau by year 2020, which can have significant adverse effects on the Canadian economy and its provincial and territorial counterparts in terms of ability to raise taxes and maintain current program expenditures and ensure a sustainable economy in the future. As a result of these pressures and complexities, governments have started to examine its role in society and the various ways through which programs are delivered and managed. For instance, governments are increasingly delivering programs and services through partnerships as a means of improving efficiency in the delivery of services to Canadians. With increasingly complex and varied configuration of delivery of public services, there exists a real need to identify separate roles and responsibilities of participating partners and to develop expectations, standards, and measures of performance to ensure transparency, accountability, and sustainability. What is Performance Measure: Definitions and Considerations One of the results of this movement for better public service delivery is the integration of private sector practices, including performance measurement to ensure transparency, accountability and sustainability even in the face of pressures and complexities facing the public sector. In recent years, several developed countries and some developing countries have made increasing use of performance concepts and results indicators, both in their managerial practices and in the formulation and execution of public programs (Performance Measurement in Public Administration, p. 649-650). Performance measurement is also considered by some experts as the first step toward improving the performance of a public-sector organization, and, if backed by an appropriate incentive system, it can help shift organizational focus from inputs to outputs and outcomes and thus improve efficiency and effectiveness (Performance Measurement in Public Administration, p.663). It is essentially the collection of a bout an organizations performance indexes that will equip a program manager to evaluate its changes in performance over time (Carroll and Dewar, 2002). Performance measures are believed to be first applied in the public sector in 1960, when calls for the improvements in processes in which the way the government manages its resources or inputs to maximize efficiency and effectiveness started becoming more pronounced. It is argued that by tracking performance, the government is better able to meet its budget goals and objectives. There are many factors to consider when developing or applying a performance measure in an organization. The main factor that must be considered is cost. Can the organization afford the costs associated with developing, maintaining and implementing a performance measure? Clear, concise and realistic performance goals are needed. The performance measure must be fully communicated to everyone in the organization, as the success of a performance measures implementation depends on everyone buying into the concept. Once a performance measure is approved, an appropriate rewards system should be included, as well as a system for modifying the performance measures if the organizations objectives are not being realized. The organization must also ensure that individuals who have to work with the performance measures within the organization are well informed about the process and the benefits of the system and how to implement it (Mayne, 2005). In other tools, realizing and achieving the full benefits of performance measurement may be compromised or limited if analysts/managers fail to appreciate and understand the nature, purpose, meaning, and limitations of the indicators. Benefits of Performance Measurement As the economy grow, the demand for government services increases as well. Ontarios gross domestic product (GDP) increased from 493.1 billion dollars in 2002 to 586.2 billion dollars in 2007 or an increase of approximately 18.9% (Please refer to appendix 1.6). This means that there could be an increased demand for government programs and services and, likely, for the Ontario governments workforce. As programs, service, and government workforce grow, there would be a need to track the various programs the government provides. Performance measures can be beneficial in a given organization in various ways if implemented properly. Some of these benefits include: workforce and program management, assessment of program effectiveness, and increased accountability. Performance measures assist in organizing information that will help track, assess and analyze how various programs are progressing over time. It is a control measure that will make sure that the public sector is delivering services to the public that will maximize the publics utility level and at the same time ensure that resources are utilized efficiently and effectively(Carroll and Dewar, 2002). The management of these processes will also ensure compliance within various departments where the process can be standardized across various departments to ensure compliance. The application of performance management hopes that managers would change from being inwardly focused to being outwardly focused on public conditions, needs and problems (Waldt, 2004, p.21). By helping managers think outside the box, performance measure will hopefully generate innovation that can be fed back into the policy process to incorporate these innovations. However, this will only work if senior management i s able to sell this idea to everyone in the organization that will help break down resistance. By overcoming these barriers, an organization can now look ahead and collect various information regarding its performance, how well it is doing in comparison to previous years?, and how it is performing against other organizations. Performance measures can also help in improving public accountability. Outcomes information will inform public debate and the political process, and thereby providing direction to Government(Waldt, 2004, p. 19). In recent years, various government sectors have faced heavy scrutiny from the tax payer, electorate, opposition parties and the media. This is due to mismanagement of government funds such as the sponsorship scandal. This is one of the reasons why various performance control measures are increasingly filtering through the public sector. Since performance measure requires information gathering, maintaining and analyzing, then its proper implementation improves government accountability, transparency and responsibility. Since the public sector is more open to scrutiny because of the advancement of the information technology and the availability of legislations such as the Freedom of Information Act, this will further assist in ensuring that public sector managers are more cons cientious. Although one must ask whether or not performance measures in the public sector exist because there is a real need to improve performance or a perceived need for one. If the cost of performance measure outweighs its benefits, then performance measures can be seen as a ploy by the government to provide peace of mind to the public. Then the cost of performance measure is essentially the cost of buying peace of mind which is a waste on its own. Finally, another benefit of proper application and implementation of performance measure is through benchmarking (Carroll and Dewar, 2000). Benchmarking allows government agencies to create and compile best practice information that can help other agencies achieve their goals. This information may be useful to other organizations to help make their operations effective. A word of caution with utilizing benchmarks is that each organization is different from one another. Therefore, these benchmarks must be modified to fit into the organizations culture, goals and objectives. Though this may be helpful, the flip side is a potential to promote laziness and block innovation (De Bruijn, 2007). Limitations to the Use/Application of Performance Measurement The main idea behind performance measures is to be able to reduce cost and at the same time provide services at the least possible cost without jeopardizing the quality of service. However, the application of performance measure alone does not mean that governments will start realizing the benefits associated with this practice. Some may question the underlying reason why performance measures are needed in the public sector. It can be argued that performance measures were implemented in another country or province and they have been successful at achieving goals through the use of performance measures as a tool (Carroll and Dewar, 2002). However, just because performance measurement works in one particular organization does not necessarily mean that it can be fully integrated in another organization and be expected to provide the same level of success (the idea of benchmarking). This brings into light various motives or the driving force for the use of performance measures. Do public sector analysts and managed really believe that performance measurement contributes to more effective financial management? Or are they simply forced to include performance measures to fulfill reporting and financial requirements from the Center of government (e.g. Treasury Board)? Or are they just following a trend or a passing fad? The implementation of performance measure in the public sector can have a few disadvantages. These limitations include the manipulation of the performance measure system, challenges and difficulties in quantifying qualitative objectives (Carroll and Dewar, 2002). One of the major problems of performance measure is the manipulation of the performance system to maximize rewards by a particular individual/organization. Performance measure objectives can be interpreted in a variety of ways that can potentially give way to manipulate the system to allow a given organization to meet its objectives on paper but not in reality. One example of how performance measure can be manipulated happened in Australia when an Aboriginal tribe was informed that its sanitation and other subsidies would depend on their performance in keeping sanitary facilities clean, they did so most effectively by thoroughly cleaning the toilets, and then closing them to the public. (p. 660, Performance Measurement in Pu blic Administration) Performance measure can be manipulated by defining the goal and manipulating other variables to meet its objectives. For instance, if a police forces objective is to decrease crime rate in a given community, it can essentially meet its goal without any real changes to the crime rate in the community in question by choosing not to report certain crimes. This practice is a waste of resources that could have been used to fund other programs that are more efficient in nature. As illustrated by the examples given, the application of performance measure can potentially generate good performance on paper but not in reality. Another disadvantage of performance measure is the challenges associated to applying it to the public sector (Graham, 2007). This is because private sector is mostly concerned with profit maximization which is a quantifiable objective. The public sector on the other hand is concerned with measuring qualitative objectives and quantifying its results. Qualitative measures can be quite challenging because it involves subjective interpretation of quality. For instance, if the governments goal is to measure the quality of secondary education provided in Ontario, and then it becomes hard to determine how well the ministry of education is performing. The reason for this is because there are a variety of ways to measure quality, where is the data coming from? What measures are used? Who measures performance? And whether or not there is a conflict of interest that will manipulate the system. Finally, quality of education may not be measured until a few years later when the students graduate h igh school. The application of performance measure also calls for rewarding good performance and punishing poor performance (Waldt, 2004). The implementation of this premise may be a challenge in the public sector because politicians can over ride budget allocation. If for instance, health care is the governments top priority, if for instance health care is the worst performing ministry within the public sector then this may be a challenge. However, this will not work in the public sector because politicians can opt to ignore the performance measure in place and increase funding for the ministry of health. It is also useful to note that the implementation of performance measurement in the public sector could potentially be more challenging than in the private sector, in part because of differing operations/service goals. While the private sectors bottom line is profit maximization, the public sector involves multiple competing stakeholders with multiple goals (Graham, 2002). For instance, there are certain stakeholders who believe in maintaining balanced books and reducing debt, while there are others who believe that the government should consistently provide for social programs, even if this implies financing services through deficit. Furthermore, a performance measures effectiveness may not be fully utilized because politicians can choose to ignore these measures or can over ride budget allocation based on performance measures. Case Study: Ontario Financial Performance Measure A budget is one of the most important pieces of legislation in any given government because it outlines how the government plans to manage its limited resources effectively. A well-conceived, -applied, or -implemented budget allows the organization to realize its goals and objectives with maximum efficiency and effectiveness (McKinney, 2004, p.264). For many years, the public sector has been experiencing increased pressure from the public to provide the best quality of service at the least possible cost. Furthermore, governments have been facing increased pressure from the public to reduce its debt, otherwise debt servicing costs will be transferred to future generations at a higher cost (principal plus interest charges). As the government becomes larger, the role of financial management plays an indispensable role in the achievement of an organizations objective. It is the fuel that gives life and substance to the engine of public administration (McKinney, 2004, p.1). Along with its growth, the number of competing stakeholders also increases and therefore, the process of allocation becomes more complicated. This is the very reason why governments are increasingly finding ways to improve its financial reporting such as the adoption of accrual based accounting and the implementation of the Public Sector Accounting standards. These are some measures used in the private sector that are now being applied in the public sector. In theory, the purpose of the application of these measures is to be able to make governments responsible, responsive and fully accountable. This section will explore and analyze the financial performance measures used by the government of Ontario to assess its effectiveness. The government of Ontarios financial analysis measures three areas which includes sustainability, flexibility and vulnerability. Sustainability measures the governments ability to meet its financial obligations. Sustainability measures Assets to Liabilities, Financial Assets to Liabilities, and Net Debt to Total Annual Revenue, Net Debt to GDP and Deficit to GDP. Flexibility measures the governments ability to move around its financial obligations across programs or across various years to be able to provide the best possible programming level. Flexibility measures Public Debt Charges to Revenue and Net Book Value to Cost of Capital Assets. Finally, vulnerability measures the extent to which the government is dependent on or can be influenced by external organizations such as the federal government, foreign institutions and foreign governments. Vulne rability measures Government Transfers to Total Revenue and net Foreign Currency Debt to Total Debt. Sustainability Assets to Liabilities measures the governments ability to meet its financial obligations through the liquidation of its assets. In the private sector depending on the company, an acceptable ratio is 2:1. However, looking at the Ontario governments assets to liability ratio, this figure hovers around 0.27:1 0.31:1 between 2002 and 2007. (Please refer to appendix 1.3). This figure may be way below the private sector expectations but the chances of a government experiencing bankruptcy (especially in developed countries) is quite low, since governments tend to have the ability to raise money by issuing debt to cover liabilities. Therefore, the use of this measure is limited to just merely observing upward or downward trends. Furthermore, with the implementation of full accrual based accounting in the public sector it becomes hard to determine the exact total value of the governments assets. These assets include heritage assets where a market value is non- existent or there are competin g estimates. It becomes a challenging task to assign a value on such an asset, or the asset may be of value to the government who owns the asset but not to anyone else. Given the challenges associated with determining an actual value for an asset, care should be taken when using this ratio as a financial performance indicator since its accuracy can be challenged. Financial Assets to Liabilities measures the governments ability to raise cash quickly or its liquidity to cover its liabilities. The Ontario governments ratio ranges from 0.18:1 to 0.23:1, where it reached its peak in year 2004/2005 and in 2006/2007 (measured at 0.21:1). (Please refer to appendix 1.3) Net Debt to Total Annual Revenue measures the governments net debt in relation to its ability to generate revenues. This ratio reached its peak over a five year span at 2.03:1 in 2003/2004 and 1.56:1 in 2006/2007. (Please refer to appendix 1.3) Since 2003/2004, the Ontario government has been able to reduce its net debt in relation to its annual revenue. Net Debt to GDP measures the governments fiscal capacity. They relate bond indebtedness to the sources of government revenue (McKinney, 2004, p.245). Ontarios net debt is hovering around a quarter of its GDP and between 2002 and 2007 where it has been slowly declining from 0.27 in 2002 to 0.24 in 2007. (Please refer to appendix 1.3) Since a consistent downward trend exists in this measure, this means that the government is improving in this ratio. Since both Net debt and GDP has increased from 2002 to 2007, this means that the GDP has increased at a faster rate than the increase in net debt. This means that governments ability to pay its debt obligations has improved over five years. Deficit to GDP measures the governments deficit in relation to its GDP. In this measure, the government has seen improvements from 2003/2004 to 2006/2007. This means that the Ontario government is continuously managing its expenditure and making sure it spending is within its capacity. Even though the Ontario government has seen deficits in the years 2003/2004 and 2004/2005, this ratio is looking favourable since deficits are declining in relation to GDP, which has seen a constant increase over five years. (Please refer to appendix 1.3) Flexibility Public Debt Charges to Revenue measures the governments ability to raise funds to pay its debt servicing charges. In this measure, the Ontario government has seen a constant improvement or a downward trend during the five year term from 14.9% in 2002/2003 to 9.7% in 2006/2007. The reason for this is because Ontarios revenues over the same five years have seen consistent growth and have increased by approximately 31.8% while interest on debt has seen a 13.7% decline over the same period. (Please refer to appendix 1.3) Net Book Value to Cost of Capital Assets measures the true value of the governments capital assets. This value is hovering around two thirds of the cost of capital assets and it has seen a slight downward trend from 69.5% in 2002/2003 down to 67.2% in 2006/2007. (Please refer to appendix 1.3) This figure is a good indication of the governments capital assets such as land, buildings, and transportation infrastructure such as highways, railroads and bridges. However, looking at the Ontario governments public accounts, it does not state whether or not the value of land is recorded at historical cost or fair market value. If the land is recorded as historical cost, then it does not really show the true value of the governments assets; instead it is under estimated if the value of the land increases in market value and vice versa if it decreases in market value. Furthermore, depreciation is measured based on estimates; it could be that the life span of an asset could be higher than expec ted and therefore, while the asset is recorded on financial statements as having no value, the asset could still be utilized. Furthermore, an asset can be estimated to have a lifespan of 10 years; at year 10, even though the asset can still be used, an organization can continue using the asset or request for new funding for the replacement of the asset. Since the asset can still be utilized, the organization can sell the asset and make money out of it (scrap value) and record it under its miscellaneous revenues. This becomes an issue of operational efficiency versus manipulation of assets to maximize revenues. Vulnerability Government Transfers to Total Revenue measures the proportion of the federal governments share of the province of Ontarios total revenue. Federal funding that flowed into the provincial government ranges between 13% (2002/2003), which is its lowest level between 2002 and 2007, and has increased steadily to approximately 15.8% (2005/2006) and dropped slightly to 15.5% in 2006/2007. (Please refer to appendix 1.3) This figure can be interpreted in various ways where the upward trend shows that the federal government is continually increasing its transfer payments to the province of Ontario in relation to its total revenue. Looking at nominal figures, the federal government has increased its transfer every year between 2002 and 2007 (from 8 billion dollars in 2002/2003 to 14 billion dollars in 2006/2007. (Please refer to appendix 1.2) Part of this increase is due to huge surpluses the federal government has been reporting in recent years. However, the increased in federal transfer can b e seen both negatively and positively. This can be viewed positively because the province is able to provide more services to the public. However, funding commitments can be revoked especially with a change in government and government priorities. Furthermore, budgetary models are built upon expectations, if the province expects to receive a certain amount of dollars from the federal government, and this is not realized, then it can potentially adversely affect the financial standing of the province. The provincial government should also use this figure as a sign of caution in terms of its forecasts not to rely heavily on federal transfers. The province should try to provide the same level of programs and services to its citizens without relying heavily on federal transfer payments because of fluctuations and uncertainty. However, others may argue that increasing federal transfers is a positive step towards addressing the so-called fiscal imbalance and providing Ontario a fair share of federal funding that is more proportional to the contributions that Ontarians make to the federal tax base. This demonstrates another useful limitation/caveat: performance ratios/indicators are not purely objective, in that their interpretation and ultimately the manner in which they are used/applied depend on the subjective point of view of the public sector analyst/manager. Net Foreign Currency Debt to Total Debt measures the provinces debt level to foreign countries and or organizations. This figure has seen an increase from 21.4% in 2002/2003 and 23% in 2004/2005 and from that point it declined to approximately 20% by 2006/2007. (Please refer to appendix 1.3) This measure is a good indicator on Ontarios reliance on foreign governments in terms of trade and its indebtedness. A declining net foreign currency debt to total debt means that the province can have a positive effect on the provinces credit rating that assesses the governments vulnerability and stability which can have an impact on interest rates on its debt. An improving credit rating will increase the chances of the Ontario government to refinance its maturing debt because of lower risk of default from its debt. An increase in this ratio might cause international panic where other countries can call the province on its debt that can have adverse effects on the economy in terms of attracting investors and other countries willing to do business with the province. As a useful summary of the provinces dependence on foreign debt, it is important to keep track of this budget measure of vulnerability. Discussion of the Ontario governments Financial Analysis as a Measure of Performance Based on the above discussion the ratios used by the government of Ontario is a useful tool as part of a comprehensive strategy or approach to analyzing, measuring the provinces economic and financial performance. However, these tools alone are clearly not sufficient to obtain a full and clear picture and forecast of the economy. Variables such as domestic and international political conditions, international and domestic commodity prices, supply and demand, price of oil, interest parity, price parity, and other non-financial indicators, such as demographic trends, should be considered when formulating, implementing, and assessing the effectiveness of policies and programs. Furthermore, these budgetary performance measures tend to be applied at a relatively high level (i.e. on rolled-up or summed-up figures or estimates) with a view to gauging whole of government performance. Since the Ontario government comprises of individual ministries and departments, improving whole of government performance must start with the individual ministries and their specific programs and projects. This reinforces the idea that full and effective performance measurement entails consideration of other and more specific factors/elements. The government of Ontarios financial measures provide very useful snapshots of the government position at a particular point in time. However, there are other measures, information and factors that one has to consider in gauging the performance of the government and formulating recommendations and strategies moving forward. Conclusion Increased pressures and complexities confronting the public sector has encouraged the proliferation of private sector practices, including the use of performance measurement to gauge program outcomes and ensure transparency, accountability, and sustainability of government operations. As this paper has demonstrated, there are benefits to performance measurement, such as providing opportunities to track, compile, and maintain data and requiring regular reporting, thereby helping in promoting transparency and benchmarking. However, these financial/material indicators are not sufficient to ensure effective and efficient management of public resources. As this paper has pointed out, there are several limitations and caveats to performance measurement that public sector managers/analysts must bear in mind, including the need to incorporate other information (e.g. non-financial and qualitative data) in developing, implementing, and assessing policies and programs. These points were reinfor ced in this paper through an examination and evaluation of financial ratios intended to measure the performance of Ontarios budget between the period of 2002 and 2007. While this paper presented a case study of performance measurement from a financial perspective, perhaps a more interesting and richer case study would be to explore quantifying qualitative program performance measures in which represents another area of future research. Indeed, performance measurement when used in a public organization by itself is a fools gold (Carroll and Dewar, 2002).