The Future of Regulation

The recent sub-prime crisis in the USA and the maelstrom of financial damage that has ensued in the USA and elsewhere has provoked an intense debate on the extent of regulation of financial markets. Debates on big issues such as these are a good thing for public policy, for the economy and for society in general, because clashing perspectives on a problem or cluster of problems often can be synthesised into a workable improvement of the status quo. The problem with this particular debate is that the clash of perspectives is so stark that it offers little for anyone who wants to improve present arrangements to work with.

In one corner we have the apologists, the defenders of the indefensible who continue to argue that all is fine and that our present problems are to be blamed on a few miscreants, who are now disgraced or on the way to gaol...or both. Of course, this leaves the system free of blame and not in need of change. Which leaves us all exposed to more crises of this type and probably even worse.

In the other corner we have the advocates of regulating everything to death, who are using the present circumstances to argue that the only way forward is to go backward, to a time when lending and borrowing money was a privilege reserved only for the rich. They may not know this, they who argue for ever greater regulation, they may not understand that this would be the outcome if their advice were followed - but that is what would happen if they had their way.

Because our present regulatory system is already somewhere between these extremes it is hard to find a constructive way forward. Allow me to suggest a possible path to a better world.

The first step is to understand that in a globalised, hi tech financial world, what happens in the USA will affect everyone. The next step is to understand that what happens in a large economy like the USA will affect everyone a great deal, for good or for ill. The third step is to build on this understanding to construct a more flexible global framework to regulate the world's finances. By flexible I mean a framework that can deal differently with different levels and types of risk and that can adapt quickly, to act more quickly than the lumbering processes of governments and central banks can do now in response to challenging circumstances.

In the next blog, I will explain how this could be done.

Efficiency v effectiveness

There is much ado these days about the potential of information technology to make government more efficient and effective. Unfortunately, the debate is generally biased to the former; the priority is cost-cutting, not value creation.

This is unfortunate because IT offers a much greater potential return for investment in government if the focus is on effectiveness first, efficiency second.

In the world of commerce, it is well understood that you establish a market for a product or a service by meeting (or exceeding) the expectation of customers. Having secured a place in the market and with production increasing as a result, you can gradually wind down costs, for three reasons: first, as volumes grow, unit costs generally fall; second, once you have amortised (or recovered) your initial investment, your profit margin per unit increases; and third, it becomes possible to secure repeat custom; and repeat customers are cheaper to keep than new customers are to acquire.

Following this type of reasoning, it is argued that investing in new IT, for example to build a new system, replacing an older, less efficient system, will reduce the cost of government. That is a flawed argument.

Let us say that the old system produces widgets at a rate that is twenty per cent more expensive than a new system. Let us also assume that the old system had cost one million dollars to develop, now fully depreciated. The new system will cost three million dollars to develop and will have an operating life of seven years.

Simple, you say, with a unit saving of twenty per cent, we will make our money back and more over seven years. This may be so in the private sector, but it is not so simple in government.

First, depreciation is meaningless in government. Depreciation makes sense only where you can claim a taxation benefit as you gradually write off the asset. Government does not pay tax, which means that a million dollar cost is a million dollar cost, not a million dollars less any tax rebate or deduction. Also, government does not make money by providing services, which means that there is no revenue produced by the use of IT to support service delivery.

This means that the true unit cost when the new system is commissioned is not twenty per cent less than for the former system, because when you have built the new system and spent three million dollars on it, you still have one million dollars of investment on the old system that you have not recovered.

I know that accountants will cringe when they read this, because that is not how accrual accounting operates. However, in government at least, accrual accounting, in my opinion, does not represent reality accurately.

To make this plain, let me put it to you this way. In 2000, I buy a washing machine for $1,000; it costs me $1 dollar per wash to run, and it still works. Now, in 2007, I want to keep up with the Joneses and I buy a new washing machine, for $3,000. I will keep it for seven years, just like the first one, and it will cost me $0.80 per wash. Note that if I do a hundred washes every year (about standard, I think in a household with no children), the savings will be small by comparison with the cost of sourcing a new machine. However, the new washing machine is easier to use and it looks a lot better than the old one; the value of this purchase to me is not financial.

After all, is anyone going to give me back the $1,000 I have already spent on the first machine, when I buy the second machine? I doubt it (no one gives that much for a trade-in!), so I start the second sourcing cycle with a sunk cost of $1,000. It is not a good deal financially; and the same logic applies to government use of IT.

And here you might say, ah, well the problem is volume. The new IT system will support many more units of service, thus filling the cost gap. I wish it were so, but, in government, rising volumes do not necessarily result in reducing costs. Sometimes they even generate a higher total cost, because hidden demand is suddenly revealed by the introduction of the new service or by lifting service quality.

If you make government benefits or services more visible and easier to get, the cost to government (to taxpayers) goes up. As is the case with my washing machine example, because no revenues are being generated, the cost of the initial investment cannot be recovered easily, if at all. Lastly, repeat custom for government is a source of expense, not revenue or efficiencies.

So, in this sense at least the private sector and the public sector differ dramatically – there is a much weaker case in the latter to justify an investment in IT on the basis of efficiency.

However, by investing in new IT, government may be able to provide a greatly improved service to the community: easier to access, cheaper for the user, better protection of personal information (and so on). If so, for a three million dollar additional investment, taxpayers and citizens would get much greater value, which means, in turn, that government would also get value in the form of appreciation of its efforts on behalf of the community.

The problem is that these forms of value are very hard to quantify; the metrics, if they exist at all, are of poor quality. Until there are better metrics, arguments will continue to be made on efficiency grounds, unfortunately, and investment decisions will continue to be biased by the wrong drivers.

The importance of learning

It may turn out that other species on Earth have developed a form of language, but there is no evidence that any species other than Homo Sapiens tells stories. The subject matter has varied greatly, from tales of giants, to tales of gods, onto romance, crime and adventure, down to the tales, homilies and diatribes pouring out of the many branches into which knowledge has been split by modern science.

The scientists might not be aware that they are engaged in story telling and might even deny it, fearing it might taint their work with the brush of subjectivity or, worse, with the whiff of fiction.

However, if you were to read Darwin or Stephen J Gould or Paul Davies or Stephen Weinberg, you would see that good science is the telling of a connected series of happenings, rising above the realm of data and information to give us access to learning and, sometimes, wisdom.

Stories come from within us and also shape us, as individuals, as communities, as nations and as a species. Stories carry the memes that make us who we are, generally in cooperation, but sometimes in conflict with our genes.

In the beginning, stories were painted on cave walls or told kinesthetically, with and through objects and rituals. Then, the spoken word took over. Skilled and highly respected individuals roamed the world connecting people and communities through their story telling. More recently, as alphabets were invented and the scribes assumed pre-eminence, stories were written on whatever material technology could supply. The bards were confined to the stage and then to the cinema and TV.

Despite the seeming prevalence of visual media, the printed word remains dominant. We consume almost twenty thousand times as much reading material as people did at the beginning of the printed book, in the Middle Ages. Ten billion books are produced each year[i].

Despite the appearance of great change, not much has changed, really, between the time of the scribe and the time of the printing press or of the e-book. Technology has made the written word cheaper to produce and cheaper to consume, but the creative process has remained largely unchanged.

This may not be so for much longer. It may be that the very nature of the creative process if being reshaped. A process that has been with us since our time in the caves is perhaps about to evolve into something new. There are straws blowing in the wind that presage that the times are changing, as a late 20th century bard used to tell us.

The growth of blogs (a neologism derived from "weblog") - and, to a lesser extent, of online publishing - is an indication that story telling is alive and well, but it is also an indication that peer to peer story telling is assuming greater significance. Intermediaries are being removed from the publishing supply chain and from the creative process and this may reshape the future of the book, of story telling and of the species.

If this topic is of interest, please have a look at this.

i. From Man, John. Alpha Beta. London: Headline Book Publishing, 2000.

Why governments should value knowledge

The OECD has highlighted the rise of the "knowledge economy", emphasising that the ability to create, distribute and exploit knowledge is increasingly central to competitive advantage, wealth creation and better standards of living.

We, the governments of Denmark, Finland, Japan, the Netherlands, Sweden and the United Kingdom, recognize that in a knowledge based economy "intellectual assets", such as human assets, innovation assets (e.g. intellectual property rights, know-how), and organizational assets (e.g. management of business/technology, employee relationship, customer/supplier network) play a critical role for accelerating both industry's and country's economic performance.

OECD "Value Creation and Intellectual Assets"

This focus on knowledge as a creator of value should not surprise us, because we are social animals, who rely on knowledge to exert mastery over other species, the environment and each other.

Humans, like most primates, are social animals and very little of what we do is done in isolation, away from others. In fact, the world would be both incomprehensible and unmanageable if we did not organise ourselves into larger entities - companies, churches, lodges, counties, provinces, states, nations and so on.

Most of the value in the world, public or private, tangible and intangible, is created by or through organisations. At the beginning of the 21st century, the capacity of organisations to create value is both exploding and, paradoxically, under threat - or so it appears. The fundamental cause for this situation is the explosion in information we have been experiencing for some decades.

Leaving aside the electronic data explosion, ten billion books are produced each year in the world and that number keeps on growing. The global economy is developing beyond the range of international governance structures.

Globalisation is challenging the raison d'etre that has supported nation states over the last couple of centuries. The nature of the nation-state is changing through economic pressure, while the emergence of truly global companies is leading to ever-greater capacity to challenge national governments.

Let us accept that it is beyond our scope to debate whether globalisation is a blight or a boon or merely a feature of the environment, like the weather. For our purposes, it is sufficient to note that we live in a globalised economy. This may be a cliche, but it is nonetheless a useful descriptor of the current state of the world, economically, socially and culturally.

Globalisation is often characterised as an economic phenomenon, involving the increasing interaction, or integration, of national economic systems, especially by means of international trade and capital flows. However, it is not only money that moves freely and quickly across increasingly porous borders.

As recognised by the European Union charter, people and cultural values also are increasingly free to move around the world and to set up home wherever a welcoming environment is found. Globalisation and modern communication technologies enable capital, knowledge and culture to be shared around the world almost simultaneously, with dramatic effects for all of us.

The volume of data and information they are required to manage is challenging organisations in the public sector and in the private sector and it is becoming obvious that in the modern economy value is created by the wise use of data and information, by managing and exploiting knowledge. There is growing recognition of the value of knowledge management as a strategic and organisation design tool.

Everybody gets so much information all day long that they lose their common sense.

Gertrude Stein

Is this how you feel, at least on the bad days? This is not a new phenomenon. As early as 1964, Peter Drucker wrote,

Other resources, money or physical equipment, for instance, do not confer any distinction. What does make a business distinct and what is its peculiar resource is its ability to use knowledge of all kinds - from scientific and technical knowledge to social, economic and managerial knowledge. It is only in respect to knowledge that a business can be distinct, can therefore produce something that has a value in the market place.

I do not know precisely what Drucker meant by the term knowledge. Perhaps he meant this,

Explicit knowledge is formal and codified, e.g., documents, databases, knowledge bases. Tacit knowledge is informal and uncodified, e.g., that found in the heads of employees, customers, vendors. It is experiential, ephemeral, transitory, and difficult to document.

Carla O'Dell and C. Jackson Grayson

It is internalised by the knower over a long period of time, and incorporates so much accrued and embedded learning that its rules may be impossible to separate from how an individual acts.

Thomas Davenport and Laurence Prusak

When I use the term knowledge, I mean information plus belief, as we will see later. Why does that matter? Well, that comes later as well.

Re-engineering government

The next phase of the ICT revolution will centre on (tele)communications and will enable or even force a significant reshaping of all value chains in the economy, particularly in the service sector.

Whole layers of intermediary activities will be reshaped or even removed altogether. This will apply to the public sector as much or even more than in the private sector, given that the business of government is fundamentally about services and relies almost entirely on information and communications.

The effective and comprehensive use of ICT tools will increasingly make it possible to re-engineer business processes so as to focus business processes on delivering end products (or services), rather than intermediate outcomes. At present, each government agency (or "silo") has its own objectives and strategy, which do not always align with those of other agencies that contribute to the eventual achievement of a government outcome.

For example, in Australia as many as seven different government agencies (and some private sector organisations) are part of the process of enabling an unemployed person to remain a viable member of society and of the economy - this is typical in any complex economy. Yet, while they share responsibility for producing a common outcome, their business processes remain separate, sometimes overlapping, sometimes duplicating, sometimes leaving gaps that ought not to exist.

Similarly, when it comes to policy, the process ought to be common across agencies, including gathering data, analysing data, understanding the present and future environment, identifying and quantifying risks and opportunities and generating options that are more likely than not to bring about a desired future position.

Yet, while a common process would deliver greater quality, reliability, and efficiency, each department labours to create its own way of doing it, inventing the wheel over and over again and creating artificial barriers to the transfer of ideas, resources and people.

The public service of the future could be much smaller and more effective. It should retain control of strategy and of the network of data and information it needs, as well as over security of data, information, installations and intellectual capital. It should source externally the hardware and applications it needs to support its activities and programs and most direct service delivery.

It should be focused on outcomes, rather than outputs. It should bring together the best people from within and without its ranks to work on projects to deliver agreed outputs, growing and expanding in size and scope to reflect shifting government priorities. It could be as small as 65% to 70% of its present size in Australia, given current responsibilities - the reduction in other countries may be proportionally greater still.

Government infrastructure has been used for nation building in different ways, with varying success.

Government activities are often of such a scale that they can generate successful patterns of activity or facilitate the emergence of clusters of positive activity. The problem is that there is no direct causal connection that can be mapped and deployed ahead of time. Wisdom comes only after the event and a pattern that has succeeded once may not be amenable to replication later or elsewhere.

The inescapable conclusion is that the infrastructure of government must be made more flexible, more amenable to constant reshaping that is driven by need, rather than by prior intent. The infrastructure of government and the operational infrastructure of business and of our civil society must be made to simultaneously complement and challenge each other, to the benefit of the future.

The boundaries between public and private economic and social activity must become even more blurred than they are now, even at the risk of losing their separate identities. In this convergent world, government would have a very great responsibility, charged with the task of engendering an ideal vision of the future and with fostering cohesive values in a diverse culture.

Business would be responsible for generating wealth for all, within that diverse culture and those cohesive values, and civil society would continue to act as the engine for altruism, the guardian of individuality and the repository of our moral and spiritual values.

This would form a web of accountabilities within which each party, under the rule of law, keeps the others in check while remaining free to pursue its own interests in the way and by the means it considers best.

Accountable government, part 4

Transparency

It is essential that government focus on creating value, but wealth is a necessary and not sufficient condition of accountable government. Transparency is also essential.

Secrecy is the enemy number one of accountable government, just as it is incompatible with the application of the rule of law. It is imperative that governments and courts act in the open, under the scrutiny of all, at least as a matter of principle.

I would argue that democracy depends more on the rule of law than on the ability to vote to elect parliaments, presidents and so on. Many countries where people can vote are not democratic; every country where the rule of law applies is a democracy. The rule of law, aomng other things, limit the capacity of the state to keep things secret, invisible, inscrutable. The rule of law makes governments accountable.

Accountability is linked to the concept of public trust. It is an essential element of any governance framework in the public sector - and increasingly in the private sector. Networks and federated governance structures tend to take the form of representative committee structures that operate outside traditional accountability mechanisms.

The result may be an accountability vacuum and diminished transparency or at least a perception that this is so.

As a result these structures are susceptible to conflict of interest issues (lazy procurement by government, where the interests of the staff are put before the interests of the public, for the sake of convenience, or patronage, in its many forms) and "pass the buck" attitudes, where government agencies tend towards inaction or a minimalist approach because roles and esponsibilities are not delineated clearly.

If conflict of interest issues are left unscrutinised, unmanaged, unresolved, then fertile ground is created for corruption and for the corrupt.

At the operational level, there is a need to ensure that any given governance framework should provide strong and clear lines of accountability, by supporting cross-agency funding and reporting on shared outcomes - collective accountability.

When networks are formed, the network needs to agree on a clearly articulated role and purpose for the network, the roles of those involved, and their responsibilities and reporting mechanisms and processes.

Access to quality, timely information is essential to the workings of government. Its availability, exchange, quality and timeliness are essential within any network or federated governance structure.

Networks and federated systems depend on their information flows between stakeholders and their capacity to analyse and interpret information. The underpinning infrastructure, the information flows and the willingness and motivations of stakeholders raise risks that will impact upon the benefits that can be gained from a networked environment.

The "protect your patch” behaviour evident in some agencies may affect the information provided by advancing certain interests. Capacity to interpret and undertake sound analysis and arrive at good policy decisions may be lessened due to a lack of expertise, knowledge of the context, history, stakeholders and so on.

Where networks are closed (or perceived to be closed) and the decision making process is not transparent, decisions may be based on misinformation or flawed analysis.

Accountable government, part 3

Public value for public money

In the public sector, as in the private sector, the function of an organisation is to create wealth (or value) by using the factors of production to best advantage. The material difference is that the private sector is primarily concerned with creating private value, while the public sector is primarily concerned with creating public value.

The objectives of private sector organisations ("the firm") and of non-commercial public sector organisations ("the department") are indistinguishable in their nature, though they may differ in form and in presentation. It is possible to start from the assumption that both private and public sector organisations are about creating value for buyers, an approach reflected in the purchaser/provider model.

Apart from government business enterprises, the value created in the public sector is not always measurable by reference to a monetary yardstick or by a measure such as return on investment. The wealth created by a department of state is defined by reference to the meaning and importance attributed by a significant observer to a particular activity, set of activities, outcome(s), process(es) or, sometimes, input.

Elected representatives (for example, Parliament) may consider that adherence to a particular process (compliance) is of greater value than the achievement of a specific result at a particular cost (outcome). Until recently, spending the allocated budget (input) - and no more or less - was considered inherently valuable.

This kind of analysis complicates the process of value creation and of decision making beyond the classical model of the firm, which requires of the firm that it be profitable; that is that it meet its costs and generate a return to its owners that is commensurable with their investment.

In reality, the interests of different stakeholders are neither equal nor equivalent, as we will see shortly. It is accepted by economists that the firm operates under several constraints, related to resources (e.g. availability of essential inputs), output quantity or quality (e.g. delivery requirements or customer service standards or industry quality standards) or legal matters (e.g. environmental law, trade practices legislation).

If the firm remains profitable within the existing constraints (and adapts as they change) it can be reasonably expected that it will meet the legitimate expectations of the shareholders (or owners).

Accountable government, part 2

Objectives and a strategy for government

From the assumption(s) discussed in the previous post, objectives at three levels can be derived for government, applicable at any level of government. Indeed, these principles - with minor modifications - are applicable to any form of social organisation, including business enterprises.

1. First level objective: increase economic and social wellbeing, by improving the competitiveness of industry, as measured by return on investment ("ROI").
2. Second level objective: maximise the potential of information and communication technologies to transform the economy, by increasing productivity, productive capacity and quality.
3. Third level objective: optimise use of information and communication technologies, transforming the operations of government, at all levels, so as to enable a broader, faster and deeper process of transformation of the economy.

To achieve these objectives, the overall strategic aim is for the government to enable innovation by providing leadership and by acting as a catalyst for positive change, focusing on the creation of public value and on facilitating the creation of private value.

Accountable government, part 1

We live in a globalised economy, characterised by the growing importance of information as the raw material for value creation and by the diminishing importance of distance as a barrier to market. The speed of change is increasing and the rules governing value creation and competitiveness are under challenge.

These challenges are especially great for small to medium economies outside powerful trading blocs, but similar levels of threat may arise for regional economies within larger economies or trading blocs.

Over the next twenty-five years, the internet (mark 1 and the incipient mark 2) and the accompanying communications revolution will aggregate economic and intellectual capital to levels of concentration that will surpass our already high concentrations.

Moreover, economic cycles and product (and services) lifecycles will continue to shorten, placing ever-greater demands on a country's capacity to innovate and to commercialise.

If a country or a region cannot compete, it will lose jobs, export markets and our best brains, to the point that it may become a consumer market supported by primary industries and tourism - and no more - prey to transnational interests and at risk of destroying its environment by over-exploitation.

The corresponding and equally great threat is that, if country or a region is unable to compete, then its people may want to again withdraw into an isolationist, protectionist shell, within which a long lingering decline would surely ensue.

The example of Argentina is there for us as a salutary lesson. At the dawn of the 20th century, Argentina was one of the wealthiest countries on the planet; at the end of the 20th century, it was a stagnant economy, with a continuing risk of losing its grip on democratic, civilian government.

However, there is a way forward for small to medium economies, to a prosperous, fair, sustainable and exciting century of achievement, realising the potential inherent to economies that are participating in a globalised information-based economy.

This is fundamental to the issue of government accountability. The first accountability of government is to enable the creation of the future the people want and expect - and to be seen to be doing so. That means that government must establish, explain and act on explicit strategic objectives.

Confidence, trust and security

Confidence, trust and security are powerful online enablers. Government should build public trust and confidence in going online and address barriers to consumer confidence in ecommerce and other areas of online content and activity.

Society must have the confidence to go about its business without fear, fear of terrorism, of deficient infrastructure, of breakdowns of major components of the financial system, of the weakening of the rule of law.

If communities, enterprises and individuals perceive that the globalised information economy is not serving their particular needs or if they perceive that the benefits flowing from that economy are distributed in a grossly unfair manner, the acceptance and trust in the new technologies will wither.

And the national economy and community life will also wither.

To avoid this, we need to know what communities, enterprises and individuals need, what they want, and what they expect. If there is congruence of needs, wants and expectations, it is more likely that there will be greater confidence in the information economy and in its tools. We need a level of confidence such that people and enterprises will feel safe in making investment decisions and in using those tools.

Developing a successful and sustainable information economy requires a social as well as a political consensus as a prerequisite. Then, a mechanism to integrate private and public interests is essential for the maintenance of that consensus. The problems that emerged in the dairy industry deregulation process - and that may emerge with the introduction of the Government "access card" - illustrate how a painfully constructed consensus for change can quickly dissipate when the pain of change starts to affect private interests.

The value to the public interest can easily be lost among the multiple private interests that exist in such circumstances. The challenge is to bring about change that satisfies both public and private (or regional or sectoral) objectives and, most importantly, to do it in a way that is perceived to be fair to all those interests.

This is where culture intrudes and its influence cannot be ignored. Managing a range of complex factors over time to maintain a consensus for change and to retain control over direction requires the capacity to integrate the needs of many and a high degree of flexibility.

The marriage of integration and flexibility enables an organisation or a country to be responsive to the developing environment and to the changing needs of its constituent parts. Also, security and predictability are essential if a country is to attract and retain the level of foreign investment it is likely to need. The need for investment in a growing economy can rarely be satisfied by domestic sources alone, especially in a medium size economy like Australia, which needs to spend big on infrastructure for the future.