Why It’s So Hard to Cut Costs in Government

Why It’s So Hard to Cut Costs in Government

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Why It’s So Hard to Cut Costs in Government

Public Sector
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  • In This Article
    • When faced with the need to cut costs, the public sector lacks a common measure of value, equivalent to profit in the private sector, to guide decision making.
    • When embarking on a cost-cutting initiative, governments generally rely on one of four approaches: pragmatic, deliberative, managerial, or adaptive.
    • A better alternative is a "value based" approach to cost cutting that, by focusing on those actions most likely to deliver results, can dramatically increase the odds of success.

    Governments around the world are facing a range of unprecedented budgetary challenges, and many will be forced to implement drastic cuts. Yet most public-sector cost-reduction programs fall short of their targets, despite detailed plans and a significant amount of political will. Why is cutting costs in government so difficult?

    In the private sector, decisions about where to cut costs (and where to invest) are informed by the likely impact on an enterprise’s future profitability. While judgment is part of the equation, building shareholder value is the primary goal.

    In contrast, the public sector lacks an overall measure of value equivalent to profit, so administrators cannot rely on a singular focal point—a lodestar—to guide their decisions. When embarking on a cost-cutting exercise, public administrators confront all the same strategic, organizational, and management challenges faced by their commercial counterparts, with the added complication that their actions will not culminate in a commonly agreed-upon measure of success beyond a reduced level of spending.

    Four Approaches to Cost Cutting

    We examined dozens of public-sector cost-cutting efforts around the world, from single-agency to whole-of-government efforts. In a future article, we will discuss in greater detail how governments can adopt a more strategic approach to cost cutting. Here we provide an overview of the most common approaches.

    The best way for a government to overcome the lack of a lodestar to guide its cost-cutting decisions will depend on a number of variables, including its starting point and context, the time frame within which it needs to cut costs, its appetite for radical change, and the clarity of its strategic direction. We have observed four broad approaches:

    • Pragmatic approaches focus strictly on measuring costs instead of value. An archetypal example is the “salami slicing” method, in which a standard budget cut (of, say, 5  percent) is applied across the board. Other examples include replacing only one out of every three departing staff members, freezing spending on particular functions, such as marketing, and making universal cuts to public-sector salaries or pensions. The French government adopted many of these tactics during President Sarkozy’s Révision Générale des Politiques Publiques (General Review of Public Policies). The benefits of a pragmatic approach are that it is unequivocal, easy to communicate, and relatively quick to implement. The challenge is that it is inevitably crude and makes little or no distinction between high- and low-value services. Muscle is inevitably cut along with fat, and so the approach is unlikely to be sustainable in the long term.

    • Deliberative approaches attempt to define value contextually through a largely qualitative process. They seek to capture the views of different stakeholders in order to weigh the relative merits of different arguments, and they are able to incorporate factors that are more difficult to quantify, such as political considerations. Deliberative approaches can also consider quantitative evidence alongside these qualitative inputs. Canada’s Program Review in the 1990s is a good example. It took into account a wide range of views but still followed a structured decision-making process in determining where cuts would fall. The benefits of a deliberative approach are its ability to combine qualitative and quantitative evidence and to engage a range of stakeholders in the decision-making process, which can make implementation much easier down the road. The challenges are that the process itself can be time consuming, and radical solutions are much harder to achieve when it is necessary to reach a consensus.

    • Managerial approaches employ the tools and techniques of business to create a “proxy for profit.” They often emphasize key performance indicators, targets, and planning. By making the best possible effort to translate the outputs and outcomes of public services into metrics, they attempt to compare the relative success of different programs or processes and drive out inefficiencies. For example, in the U.K., the Department for Work and Pensions used this approach to cut costs by 5.6 percent through a head count reduction of 30,000 employees. The benefits of a managerial response are most apparent when the approach is applied to standalone agencies with relatively clear objectives that are bounded and do not depend on outcomes in other areas. The challenge is that much of the public sector is interconnected, complex, and unbounded; consequently, applying a managerial style can have unintended consequences. For example, facing budgetary pressures, a prisons administrator may choose to reduce spending on rehabilitation programs. This will help reduce spending per offender but is also likely to lead to an increase in recidivism, pushing costs onto other public agencies (such as police and the courts), society at large, and, ultimately, the prison system itself when the offender is reincarcerated.

    • Adaptive approaches address the system as a whole in order to tackle the root causes of excess costs and inefficiency. They look across departmental silos and consider the roles of stakeholders outside government, such as service users, citizens, business, and charities. An example is the open-data movement, which encourages governments to publish their data. Making data (including spending levels) more visible can quickly highlight waste and inefficiency, which can then be addressed. Cities such as Chicago have made vast amounts of data freely available online for exactly this purpose. The benefit of an adaptive response is that it can empower citizens to signal high- and low-value services by offering them a choice of delivery channels or providers. The challenge is that it can require fundamental reforms, which take time to implement and are therefore less suitable when costs require urgent attention.

    When choosing from among these approaches, governments can select the one most suited to the context and tailor it to the different levels of a system. (See “Matching Response to Circumstance,” below.) They can also opt to apply a mix of approaches, which in some cases can be mutually reinforcing.

    Matching Response to Circumstance

    Because no single approach to cost cutting will suit every circumstance, governments are likely to experiment with different responses over time as their own needs evolve. Two recent examples bear this out.

    Greece currently needs to slash public spending far more dramatically than any other member of the OECD has attempted. Because of the urgency, an adaptive approach is simply too slow to deliver the necessary savings. At the same time, data on public spending and the performance of public services are very poor, making the managerial approach unworkable in the near term. The best immediate strategy is therefore likely to be a pragmatic solution based on relatively simple bright-line rules.

    The U.K. is partway through a fiscal consolidation program that has so far been dominated by pragmatic and deliberative approaches. While these have helped put public spending in check, they have not necessarily tackled the root causes of excess costs in the system. It now makes sense to move toward a more adaptive strategy. We can already see the beginnings of this shift as the government increasingly pursues policies that promote transparency, choice, contestability, and citizen empowerment as means of driving down costs and increasing efficiency.

    The Challenges of Implementation

    Because successful cost reduction depends on maintaining and reinforcing a strong sense of value, the implementation phase of government cost cutting is when the lack of a lodestar really takes its toll. The story is a familiar one. After the initial fanfare and publication of a grand plan, momentum for cost cutting in a public service soon falters, and early bumps in the road hinder progress. Savings in one area can simply reappear as additional costs elsewhere. Tough choices end up being fudged or avoided altogether. When more severe challenges arise, the entire effort is either abandoned or dramatically watered down. Without a clear sense of value in place, the forces against change can easily trump early momentum over the long run.

    Governments that have been able to avoid this trajectory tend to be motivated by an external crisis, such as crippling government debt yields or the threat of intervention by the IMF. Some commentators have spoken of the need to create a “burning platform” in order for government cost cutting to succeed. While this can be a very important motivator, it represents the stick without the carrot. There has to be something more aspirational to aim for in order to achieve transformative change.

    We believe that a more helpful alternative is to adopt a broader, “value based” approach that focuses on those areas and actions most likely to deliver results and create a benefit, rather than simply avoid pain. Before embarking on a cost-cutting exercise, governments should first decide how to measure the value gained by the proposed cuts. A clear understanding of the value sought can then guide both where and how the cuts are made. Exactly what that means in practice will depend on a government’s chosen approach to cost cutting.

    • Pragmatic approaches focus on the cost reductions themselves, so understanding their value requires setting clear financial targets up front, breaking them down into subcomponents, and then closely tracking costs. As government accounting systems are often not up to the job, an important first step can be investing early in robust systems that can track costs at the appropriate level of detail. Cost-cutting reforms carried out in New Zealand in the early 1990s were supported by the introduction of such systems.

    • Deliberative approaches incorporate qualitative elements to help define the value sought. This makes it particularly important to agree upon and communicate a clear rationale and a vision for the end state. Key stakeholders need to be engaged in the debate. For example, Canada’s Program Review resisted setting up-front targets and instead asked departments to evaluate all spending using six guiding principles. This required strong cooperation and collaboration between ministers and deputy ministers (official heads of departments).

    • Managerial approaches rely on outcome metrics, so it is vital for these to be agreed upon and measurable and their drivers to be well understood. For example, disease registries in health care enable clinicians and managers to track the outcomes of large groups of patients with the same diagnosis. Comparing the effectiveness of different types of interventions allows them to promote the most successful treatments and stop the least successful.

    • Adaptive approaches treat value as an “emergent” property of the system, meaning that when a variety of individual agencies operate together within an environment, their collective actions can produce complex and powerful results. The whole becomes greater than—and, in some cases, different from—the sum of the parts. Adaptive approaches emphasize factors such as feedback, transparency, agility, and experimentation. For example, in the U.K., the Ministry of Justice is piloting a new approach to recidivism by agreeing to pay a consortium of charities on the basis of the outcomes they achieve rather than the services they provide. This mechanism is designed to encourage radical innovation and to help the government avoid paying for poor outcomes. In this case, it is particularly important that the government have a clear strategic direction to guide and inform the adaptive approach.

    While governments can choose to pursue several of these ideas at once, the secret to success is to retain absolute clarity about the value being sought and to ensure that this is communicated widely and consistently. For that reason, it is often better to prioritize one approach over the others at a particular point in time.

    In the current economic climate, assumptions about the role and scope of the state are being questioned in an attempt to rein in public spending. Without a clear sense of value, many well-meaning cost reductions are likely to fail. Adopting a value-based approach to cost reduction can dramatically increase the chances of success and deliver better outcomes for citizens, better value for taxpayers, and more sustainable public finances.

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