How Similar is Governance in Public and Private Sectors?

How Similar is Governance in Public and Private Sectors?

Sam Choon Yin (11/04)

 

Introduction

Singapore’s Prime Minister Lee Hsien Loong outlined four principles of public governance in his speech delivered at the Commonwealth Association of Public Administration and Management Biennial Conference on 24 October 2004 (see http://www.gov.sg and The Straits Times 24/10/04 and 25/10/04). According to PM Lee, the principles had helped Singapore to grow as a nation and being recognised, among other things, as one of the fastest growing economies in the world. Interestingly, the same principles of governance can be applied to private corporations, as this paper will illuminate.

As such, in view of the increasing corporate scandals in both developed and developing countries, it may be useful for private corporations to emulate some of the experience and values adopted by the public sector (not necessarily in Singapore) to further improve their management practices. This essay will discuss some of the similarities in the style of governance in both public and private sectors using PM Lee’s principles as the starting point.

Essentially, corruption can also take place in private corporations although it is often discussed in the context of public governance. In the simplest terms, corruption refers to attempts by an agent to make decisions that benefit himself/herself but at the expense of the principals. An example includes manager’s decision to manipulate financial statements to reward himself/herself more than what he/she actually deserves. The use of budget as a target-setting system to determine managers' performance exacerbates the problem. So is performance based stock options plan. Some of the suggested solutions are to (1) raise the standards of corporate governance (like developing stronger boards), (2) treat stock options as expenses, (3) protect employees who whistleblow, and (4) make bonus and performance a function of accomplishment rather than linking them to budget. Particular emphasis on the guidelines afforded by the following four principles of governance would also help.

 

Principle 1: Leadership is key

Good leaders are required to lead the nation so that it could avoid hazards. In the speech, PM Lee defines a good leader as one who does what is right, not necessarily popular, and has the courage and integrity to ‘acknowledge and correct past mistakes’. A good leader must be able to initiate changes to policies that have become outdated or less relevant. In the case of Singapore, the political leaders have switched from implementing import-substituting policies in the 1960s to those that were based on export promotion with particular emphasis on attracting multinational corporations and eradication of protectionist measures. This was done despite hurting some of the domestic producers. It is also well known that decisions to cut the CPF rates were initiated by the leaders during economic downturns so as to soften the negative impact of the downturns on the city-state, but possibly at the expense of some salaried workers.

A good leader must be guided by the desire to maximise the welfare of the society through correction of market failures, stabilisation of the country’s economy and ensuring that no one suffers from extreme poverty. Good leaders are necessary to attack bureaucracy and mitigate the agency problem particularly if the oppositions are weak. Often, the government intervenes to promote growth, stability and equality of opportunity in the nation. But the means to attain them may require a long gestation period. As a result, it may possibly be more suitable to have leaders elected into office either democratically or non-democratically for several terms. Of course, if the leaders were to turn out ineffective, they would and should be voted out.

It usually takes a long time to know a person, whom may be showing off his/her projected character rather than the true character. In this respect, it is important to recognise the distinction between a good worker and a good leader. The latter possesses unique characteristics such as non-bias, motivational and inspirational (these are soft skills). More importantly, the means to lead must appear as genuine, and not in a disguised form. While a person may be a very good worker, when it comes to lead, he/she could fail to perform up to standards. This could be due to the fact that he/she does not posses the features of a good leader, but try to act as one despite being in contrary to his/her genuine character.

Judging a person’s genuine personality and integrity is not easy although it is useful to have some checks during times when the person is being tested. Some checks are present in Singapore. For example, the PAP Members of Parliament are required to declare their assets to the Prime Minister while the PM and his cabinet ministers must declare their assets to the President. The latter’s duty has also been extended to safeguard the reserves that the city-state has taken many years to accumulate, so as to prevent any unethical persons represented in the government from depleting them wastefully. In addition, the Corrupt Practices Investigation Bureau (CPIB) Director has the power to investigate all persons including the PM himself as provided in the Constitution.

Leadership is also a key consideration in private corporations. Edwards Deming, a well-known quality guru, has argued that managers were the ones responsible for problems in the system, not the workers (Deming, 1990). Basically, managers must display strong support to establish a stable system in the organisation in a statistical sense, and continuously improve the system to reduce variations in better meeting customer needs. The seventh Deming’s Principle of Management propounded the importance of leaders to help employees do a better job.

The leaders provide moral guidance to their subordinates. Moral codes of conduct may be established either formally or informally such that over time, what considered to be acceptable and morally right thing to do is moulded by powerful leaders. This essentially signals the desire to have good leaders in any organisation.

Bad leaders could result in the non-attainment of their affiliations’ objectives. In the public sector, a corrupt leader extorts payments from households and firms, forcing them to operate in the underground economy, or incur higher cost if they fail to ‘hide’ from the government. The resultant effects may include generation of low quality economic statistics (because of hidden or underground activities) thus undermining the government’s ability to make the most appropriate decisions. The government may also loss tax revenue because taxpayers refuse to contribute to the government’s pocket, thus imposing unnecessary limitations to the government in financing its expenditure programs. Moreover, if the perceived cost of bribes is excessive, local and foreign businesses may choose not to invest in the nation.

In private corporations, bad leaders demotivate their subordinates and encourage rent-seeking activities (like shirking). As a consequence, the corporations may loss market share and good workers (turnover rate of staff may be substantial).

 

Principle 2: Anticipate change and stay relevant

            As part of the initiative to remain relevant, the Singapore government introduced the Public Sector for the 21st Century (PS21) plan on 5 May 1995 to foster an environment that induces and welcomes change for greater efficiency, service excellent and cost effectiveness. Public officers are encouraged to be pro-active, open to new ideas, constantly question old assumptions, more willing to take risk, and able to understand how the market works. Historically, the PAP has taken this approach. The leaders were pragmatic and constantly on a look out for potential growth areas, setting up necessary infrastructure and kick-start unproven projects with government subsidies, and through government linked companies (GLCs).

            PM Lee is of the view that the public sector should be a facilitator of business, not ‘just’ a regulator (indicating that there is a role for the government to regulate businesses). Theoretically, this makes sense. Excessive regulations may raise administrative costs to businesses thus forcing them to ignore the rules. A bureaucratic regime is often accused of causing inefficiencies in public enterprises although the problem is also common in private organisations that have grown too large (under the banner known as diseconomies of scale).

Clearly, governments should properly study the proposals initiated by the market rather than prohibit them outright. Otherwise, there will be a strong likelihood that the rules would not be complied with. An example can be found in Stringham and Boettke (2004). Back in the 17th century, investors in Holland were required to be physically present at the company if they wanted to transfer shares to another, a practice that had imposed significant cost on the investors. Brokers found a way to lower this cost, that is, by allowing transactions to take place on one day and settling them with each other on a future date (the use of forward contract in today’s terms). The Dutch government did not like the idea as it found such arrangements wasteful and immoral. It passed ordinances to outlaw most of the transactions in share market and prohibit investors from making trades where the shares were not actually transferred within two weeks. But the law was not followed and complied with. Brokers ignored the law and continued with numerous types of transactions (like short selling and use of forward contracts).

The above example shows that imposing regulations, which are deemed excessive and unsuitable (as perceived by the market), could create non-compliance thus hindering the government from regulating the economy more effectively and rendering the government unpopular with the masses. Instead, PM Lee’s second principle of governance says that the public sector should keep up with the time and pro-actively facilitates businesses. In other words, the public sector should not remain static.

            In managing private corporations, so much has been written about ‘organisational change’. The idea essentially recognises that an organisation is dynamic and constantly in contest with others so as to capture a larger market share. Sticking to the assumption that ‘what works in the past would also work in the present and future’ is a recipe for business failure. Similarly, governments need to continuously improve on the public services it supplies in recognition of the fact that individuals are marginal thinkers.

            Kanter (2000) notes that ‘change’ is a way of life in organisations because of three forces: globalisation (to go international), information technology (to get networked) and industry consolidation (forming strategic alliance or arranging for a merger are considered bold moves to produce fast change). Despite the need to adapt to the circumstance, ‘change’ must be done gradually with the transition process properly monitored and managed. An implication of this is that stability in leadership both in business and political arenas is necessary so that similar persons with similar ideologies are present to oversee those initiatives that they have introduced. This could have partially explained Singapore’s successful transition from a third-world country to a first-world country (the ruling party, PAP, has won every election since 1959 with the PMs holding on to their position for quite a long time; about 30 years for Mr. Lee Kuan Yew – from 1959 to 1990 and 14 years for Mr. Goh Chok Tong – from 1990 to 2004).

Managing the transition process is indeed very important and relatively difficult to control. As Bridges and Mitchell (2000) notes, while organisational change is external, transition is internal. The latter incorporates human behaviour and habits which are not easy to influence at least in a short time frame and in a more certain manner. Interestingly, a resemblance can be seen between organisational change and that of the process of economic change. Both involve changes which require the agents to participate and adapt. In this respect, understanding human behaviour is essential so as to enhance the chance of a successful transition. Douglas North (2003) has succinctly describes what he thinks as the way a mind works as a nation transforms change over time. It is worth quoting his thoughts on this at length:

The neural networks of the mind gradually establish patterns by which they interpret the world, and the patterns become quite complex and elegant, as indeed many belief systems and ideologies are. … If the novel situation is similar enough to patterns that we have in our mind, that we have derived from past experience, then indeed we may solve the problems more or less accurately and enact policies and rules that improve our lives. To the degree that the situations are really novel, they pose fundamental dilemmas with respect to how we deal with them. Now, humans attempt to use their perceptions about the world to structure the human environment in order to reduce uncertainties in human interaction. The resultant institutional structure is a combination of formal rules, informal constraints, and their enforcement characteristics. By formal rules I mean constitutions, laws: by informal constraints I mean norms of behaviour, conventions, codes of conduct. Obviously the degree to which both the formal rules and informal constraints are enforced determines how effective those rules and constraints are in shaping our actions. The institutional constraints accumulate through time, and the culture of a society is a cumulative structure of rules, norms, and beliefs, that we inherit from the past, that shape out present, and that influence our future. Institutions change, usually incrementally, as political and economic entrepreneurs perceive new opportunities, or react to new threats, affecting their well-being. Institutional change can result from change in the formal rules, the informal norms, or the enforcement of either of these.

 

           One can see that managing change or initiating the change itself is common and advocated in private corporations and the economy as a whole. In both cases, successful implementation of the program depends on the leaders ability to manage agents so that they are adaptable to the changes in a gradual manner, taking into consideration intangible factors like personal skills, behaviour and relationships.

 

Principle 3: Reward for work

            Senior political officials in Singapore are highly paid as compared to their counterparts in other nations. Publicly released data showed that the country’s PM is paid S$85,000 per month while ministers are paid around S$50,000 per month. This was based on the salary revision exercise conducted in June 2002. Paying competitive salaries is seen as a necessary measure to attract and retain talents as well as to align public officers’ interest more effectively with that of the citizens. As former PM Goh Chok Tong once said, ‘That Ministers’ pay is a source of envy for some people is not necessarily bad. We are more likely to recruit good Ministers in this way. I would be extremely worried if it were the reverse. If Ministers envy pay of their counterparts in the private sector, that is the first step towards corruption’.[1] The public sector in Singapore also bases public officers’ salaries on performance, not so much on seniority. Paying competitive salary is believed to have contributed to lower incentive for corruption (Quah, 2003). Singapore is blessed with strong budgetary positions, thus allowing it to introduce and retain this practice. However, a possible limitation of this is that it may lure talents to high paying government jobs thus limiting the pool of educated citizens pursuing their careers in the private sector. As a related problem, paying competitive salaries to public officers may deter to some extent the emergence of some indigenous entrepreneurs in the nation.

The budgets for some statutory boards are also dependent on their performance. An example is the tax authority, Inland Revenue Authority of Singapore (IRAS). The incentive to collect taxes in the most efficient and effective way is motivated via the ‘pay for performance’ principle, which pegs the agency fee that the IRAS receives to the difference between the actual and projected tax revenue collected by the IRAS. In addition to the normal agency fee of fixed 1.65 per cent of the targeted revenue collection, the IRAS is entitled to an additional performance based fee amounting to two per cent of the difference between the actual revenue collected and the projected tax revenue (Asher, 1999). Moreover, statutory boards are required to plan for their budgets on a regular basis, which must be approved by the Accountant General.

Like in public sector corporations, many private corporations today are run by professional managers who do not own them. In the US, it was believed that this began when great capitalist entrepreneurs like Vanderbilt, Rockefeller, Morgan and Harriman hand over the control to ‘outsiders’ thus broadening the ownership. But there is no guarantee that the managers, as agents, would make decisions that benefit the owners. They may instead expropriate company funds to reward themselves more than what they actually deserve, travel excessively and furnish their offices with unnecessary electronic gadgets. One of the ways to mitigate the agency problem between the professional managers and shareholders is to reward the former more competitively. The intention is to lower the incentive for them to act improperly. This is similar to the approach undertaken by public sector in Singapore as we have seen earlier.

But this approach is not without problems. Often, managers’ performance is judged by their ability to meet targets set in the budgets. Linking their remunaration to the realisation of targets set in the budgets may result in the managers setting targets that are easily reached and/or trying their best to meet the targets even if the attempts damage the company in the near future. While this problem (desirability to maximise budgets) is often used to describe public sector ineffectiveness, it is also susceptible in private corporations.

In a recent article, Michael Jensen points out that in addition to being a solution to the agency problem, the design of incentive-based executive compensation plan may be seen as a possible source to the problem. Issuance of stock options plans for example gives executives the incentives to raise investors’ expectations about the corporations which may result in their overvaluation. Pressured to meet the expectations, managers may resort to illegal or creative accounting. Jensen coins this the ‘agency costs of overvalued equity’ (Jensen, 2004). Jensen suggests raising the standards of corporate governance to tackle the problem include attempts to reform the board. Our point here is that to manage private corporations effectively, paying competitive salaries to the professional managers is necessary but not a sufficient condition. Tackling the principal-agent problem must incorporate a combination of all four principles of governance outlined in this essay.

 

Principle 4: A stake for everyone

            PM Lee’s fourth principle of good governance calls for nation building. Every citizen has a role to play. He/she must have a sense of ownership and belonging to the nation. In short, community participation matters. This idea is very much in line with Third Way Politics, which defines communities of civil society as one of the key areas of power (the others are economy and government) (Giddens, 2000). Essentially, strong communities must be present to complement effective governance and economic growth. Proponents of the Third Way politics have argued that all parties who have profited from social goods must use them responsibly, and give something back to the society in developing what J.K. Galbraith might have called the good society.

            Galbraith (1996) defines a good society as one where ‘every member, regardless of gender, race or ethnic origin, should have access to a rewarding life’ (p. 23). But exceptions are allowed to recognise for ‘differences in aspiration and qualification’ where differences in ‘physical and mental facility, commitment and purpose’ could result in differences in ‘achievement and in economic reward’ (ibid, p. 23). The Nobel Prize Winner supports equality of opportunity, not equality of outcome since the latter is viewed as neither ‘realisable nor a socially desirable goal’. This is the stance taken by the Singapore government. It is well know that the city-state has a relatively weak welfare system where a significant burden of the social welfare is borne by the individuals’ themselves. Financial assistance schemes are rare and even if they are provided, they are given on an ad-hoc basis and act as merely temporary measures. Instead, the PAP has often emphasized that the best form of social security is the pursuance of high economic growth so that more employment opportunities are provided (Asher and Rajan, 2002).[2]

What is the role of the government to achieve the status of a good society? It is believed that the government has the responsibility in enhancing income and working conditions of the poor. The poor for example must be provided opportunities to upgrade themselves via subsidised education and training programs. The rich must not be allowed to acquire more wealth via unethical means like through insider trading, manipulation of financial statements and deviant investment behaviour, all of which undermine employment opportunities to the masses and affect income distribution in an unfavourable manner.

            The fourth principle implies that it is essential for everyone to cooperate to make the nation a better place to live in. This resembles the stakeholder approach in business management. The approach, popularised by Edward Freeman, argues that success in any organisation depends on the support given by the stakeholders (they include customers, employees, creditors, suppliers and interest groups) (Freeman, 1984). The managers are encouraged to work peacefully and closely with the stakeholders. The approach however fails to recognise the potential conflicts of interest among the stakeholders (for example, between the employers and employees, and between the employers and suppliers).

            Jensen and Murphy (2004) provides a modified version. Like Freeman, they recognise that the stakeholders interest must be cared for since ‘a firm cannot maximise value of it ignores the interest of its stakeholders’ (p. 15). But it is not easy to know when something has been maximised. Thus, they suggest thinking about ‘value creation’ (or change in long-term market value) as the scorecard for managers, directors and others to assess the success or failure of the organisation (p. 16). Jensen and Murphy (2004) believe this to be the ideal approach. In fact, the Japanese had introduced, much earlier, an operational approach to achieve this, known commonly as the Just-in-time system which similarly has advocated strong stakeholder participation. A JIT firm for example is asked to treat suppliers as part of the family and to retain a single supplier for at least each of the parts needed. Employees are empowered to resolve operational problems without having to wait for directions from their supervisors. The element of trust is thus very strong. The success of this philosophy has attracted many followers from economies around the world.

 

Conclusion

            What we have shown in the essay is that the four principles of good public governance advocated by PM Lee could be applied to private corporations. Essentially, there are some commonalities between running a public sector and private corporations.

It is generally agreed that the objective of public sector corporations is maximisation of net social welfare while the private corporations should aim to maximise profit. As was illuminated earlier, the notion of maximising long-term value of the firm seems to be more appropriate, one that calls for private sector managers to work closely with stakeholders in realising the goal. Undoubtedly, this resembles very much the approach used in the public sector at least based on the ideas advocated by proponents of Third Way politics. Because of the commonality in the management of the public and private sectors, learning good practices from one another may be a fruitful exercise for them to undertake.

 

References

Asher, Mukul, 1999, Tax Reform in Singapore, Working Paper No. 91, Asian Research Centre, Murdoch University, Australia.

Asher, Mukul and Revathi Rajan, 2002, Social Protection in Singapore, in: Erfried Adam, M. Hauff and J. Marei, eds., Social Protection in Southeast and East Asia, Freidrich Ebert Stiftung, Singapore.

Bridges, William and Susan Mitchell, 2000, Leading Transition: A New Model for Change, Leader to Leader, No. 16, Spring 2000.

Deming, Edwards, 1990, Out of the Crisis: Quality, Productivity and Competitive Position, Cambridge University Press, US.

Freeman, Edward, 1984, Strategic Management: A Stakeholder Approach, Pitman, US.

Galbraith, John, 1996, The Good Society: The Humane Agenda, Sinclair-Stevenson, GB.

Giddens, Anthony, 2000, The Third Way and its Critics, Polity Press, UK.

Kanter, Rosabeth Moss, 1999, The Enduring Skills of Change Leaders, Leader to Leader, No. 13, Summer 1999.

Jensen, Michael, 2004, Agency Costs of Overvalued Equity, Negotiations, Organisations and Markets (NOM) Working Paper No. 04-26, and European Corporate Governance Institute (ECGI) Working Paper No. 39/2004 (May).

Jensen, Michael and Kevin Murphy (with the assistance of Eric Wruck), 2004, Remuneration: Where we’ve been, how we got here, what are the problems, and how to fix them, Organisations and Markets (NOM) Working Paper No. 04-28.

North, Douglas, 2003, Understanding the Process of Economic Change, mimeo.

Quah, Jon, 2003, Curbing Corruption in Asia: A Comparative Study of Six Countries, Eastern Universities Press, Singapore.

Stringham, Edward and Peter Boettke, 2004, ‘Brokers, Bureaucrats and the Emergence of Financial Markets’, Managerial Finance, Volume 30, Number 5, pp. 57-71.

 



[1] The remarks were made in a statement on public sector salary revisions in Parliament on 30 June 2000.

 

[2] Third Way politics also advocate the idea of equality of opportunity but warn of the possible inequality of outcome problem. As such, Third Way politics supports redistributed because without it, one generation’s inequality of outcome is the next generation’s inequality of opportunity (Giddens, 2000, p. 89).