ANALYSIS OF PUBLIC ENTERPRISE GOVERNANCE AND MANAGEMENT ISSUES IN FICS

Transcription

1 PACIFIC ISLANDS FORUM SECRETARIAT PIFS(04)FEMR.04 FORUM ECONOMIC MINISTERS MEETING Rotorua, New Zealand 9-10 June, 2004 SESSION 2 PAPER ANALYSIS OF PUBLIC ENTERPRISE GOVERNANCE AND MANAGEMENT ISSUES IN FICS The attached paper, by the Forum Secretariat, sets out issues associated with the governance and management of public enterprises in Forum Island Countries. For Ministerial discussion.

2 PACIFIC ISLANDS FORUM SECRETARIAT PIFS(04)FEMR.04 FORUM ECONOMIC MINISTERS MEETING Rotorua, New Zealand 9-10 June, 2004 ANALYSIS OF PUBLIC ENTERPRISE GOVERNANCE AND MANAGEMENT ISSUES IN FICS Purpose This paper sets out, for the consideration of Ministers, issues associated with the governance and management of public enterprises in Forum Island Countries. Background 2. FEMM 2003 requested the Secretariat to undertake, for FEMM 2004, an analysis of public enterprise governance and management issues in Pacific nations, drawing on work by the OECD, ADB and others. 3. Indeed, extensive work has been undertaken by the ADB in many FICs to assess the operations of public enterprises and to advise on means through which management and governance of these can be improved. This paper draws together common threads in this work and points out some regional approaches which could be considered by FICs as well as common national actions to improve the governance and management of public enterprises. 4. On a related matter the FEMM Stocktake (FEMR.06) examines implementation of the Forum s Eight Principles of Accountability. Some of these principles are relevant to good public enterprise governance and management and so key points made in FEMR.06 are reiterated in this paper in relation to three principles: Principle 2 - The accounts of governments, state-owned enterprises and statutory corporations to be promptly and fully audited, and the audit reports published where they can be read by the general public. Principle 3 - Loan agreements or guarantees entered into by governments to be presented to Parliament/Congress, with sufficient information to enable Parliament/Congress to understand the longer term implications. Principle 4 - All government and public sector contracts to be openly advertised, competitively awarded, administered and publicly reported. Public enterprises in the Pacific 1

3 5. A public enterprise is an entity wholly owned by government with a separate legal personality and separate accounts that earns revenue from the sale of its goods and services. Thus the entity has the potential to earn a return on its assets. Regulatory, promotional and educational public enterprises do not typically have this commercial potential and are excluded from further consideration as their performance needs to be examined using differing criteria There is a further set of public-type enterprises found in the Pacific and these are companies with a majority shareholding by government. In effect these are publicprivate joint ventures. The issues raised below as pertaining to wholly government owned public enterprises may also be relevant to these public-private ventures, albeit to a lesser extent. Typically private sector involvement brings into play a set of control mechanisms that help to avoid many of the problems which beset purely government-owned enterprises. 7. In the Pacific public enterprises are commonly seen in areas of the economy normally considered contestable. That is those activities are readily open to competition and private sector involvement. There is widespread involvement in resource based industries (e.g. agriculture, fisheries, forestry), in transport (shipping and air transport), in the utilities and in the finance sector. A number of countries also have public enterprises with significant involvement in manufacturing, trade and tourism. 8. There are historically many differing reasons for creating public enterprises, and in most cases a number of these are applicable, however it is important that these initial objectives are reassessed to ensure their ongoing relevance and effective achievement (or whether alternate ways of reaching specific policy objectives are preferable): the promotion of certain sectors (for example Tobolar Copra Processing in the Republic of the Marshall Islands); the generation of income for the Treasury (typically those public enterprises which provide the greatest return to government are the telecommunications utilities); to provide a service or undertake a function for which there is no private sector provision, that is to overcome market failure (for example the Samoa Shipping Corporation and Samoa Shipping Services); to create competition for the private sector (for example the involvement of Betio Shipyards, Kiribati, in the retailing of hardware); the need to offset economic dominance by foreign or certain national interests (for example the National Fishing Corporation of Tuvalu); the regulation of monopoly power (this is the case for many of the public telecommunications and power utilities in the Pacific which are operated as public monopolies); 1 This exclusion is also justifiable as commercial and non-commercial bodies require differing levels of oversight and also the benefits from efficiency gains in commercial public enterprises are much greater than those available from non-commercial public enterprises and so are typically prioritised. 2

4 the promotion of the development of certain regions (for example the Captain Cook Hotel on Kiritimati Island in Kiribati); to create jobs (for example the Samoan Government s partial ownership of Hellaby s Samoa Ltd and Rothmans Tobacco Company Ltd); to manage prices (for example many agricultural marketing boards were set up with the twin objectives of equalising prices for consumers across a disperse geographic area and protecting producers from price fluctuation through multiyear stabilisation operations); and to redistribute income and achieve social objectives. Social objectives, such as allowing wide access to savings and investment opportunities, were behind many of the Development Banks and National Provident Funds created in the Pacific. 9. As a result, and also due to the inheritance of public enterprises at independence, there are numerous public enterprises in each Forum island country. At one stage the Federated States of Micronesia had over 30 public enterprises, in 2002 Kiribati had 28 while Tonga had 32 public enterprises, while in 2000 Samoa had 21 fully government owned public enterprises. However most FICs are making a concerted effort to reform their public enterprises to ensure efficient operation and some FICs have chosen to corporatise or even partially or fully privatise some public enterprises. 10. In general in the Pacific public enterprises have tended to be run more as an extension of the responsible Ministry than as independent businesses aimed at maximising shareholder value. There has been considerable variability in performance amongst public enterprises as shown by the rates of return. For example in Kiribati rates of return on total assets of public enterprises were found by the ADB (2002b) to vary from -19% to 118%. 11. In the Pacific large public enterprise losses and poor performance are attributable to a variety of factors including: inadequate government monitoring; an absence of clear accountability and performance assessments; poor commercial practices; government controls on prices; the pursuit of non-commercial activities at the Government s request; inappropriate facilities, poor quality plant and equipment; lack of skilled staff; lack of personal consequences of success and failure (ie motivation of staff); and cultural constraints faced in ensuring the payment of bills. The service quality of some public enterprises has also been criticised. Importance of public enterprise governance and management in the Pacific 3

5 12. There are strong arguments as to the vital role for strong public enterprise governance and management that are applicable to the Pacific. 13. Accountability demands readily visible and improved performance. The Government has been entrusted by the community to manage public resources. The community will be best served when public enterprises are efficient in their delivery of goods and services, are responsive to the needs of customers, and report regularly and fully on how resources are used. 14. The large size of the public enterprises in relation to the economy and also to the private sector, and its strategic importance, requires increased efficiency of resource use. Public enterprises must be an efficient user of scarce resources, replenish existing capital assets, and assist the economy to create new assets for future incomes. However the provision of goods and services by public enterprises commonly provided in a competitive market environment is not always done efficiently in the Pacific. 15. Strategically vital parts of the economy are operated by public enterprises, for example telecommunications and airlines. The corporate governance of all public enterprises is of great importance to the overall equity and competitiveness of the economy. 16. Development of the private sector requires improved performance of public enterprises as the quality, timeliness and price competitiveness of their outputs affects the efficient operations of the private sector. Indeed poorly performing public enterprises can undermine the private sector by requiring support which diverts funds from alternative uses important to the private sector such as infrastructure provision or they require a higher level of taxes than need otherwise apply. For example, ADB (2000) noted that Samoa government grants and subsidies to public enterprises accounted for around ten percent of total government expenditure. Poorly performing public enterprises can also act to crowd out the private sector and can further hamper private sector development by being poor payers for services and goods from the private sector. Issues 17. This paper considers a number of issues of importance to public enterprise governance and management in the Pacific, based on an examination of the role of government in relation to public enterprises. 18. The World Bank (1987) used the experiences of private companies with subsidiaries to clarify the decisions in which the government should be involved for public enterprises. This analysis forms the basis for the following discussion of issues concerning the role of government in public enterprise governance and management: set the basic objectives and provide operational autonomy; appoint the Board members (leaving appointment of a Managing Director to the Board); set clear performance measures, evaluate performance, and reward or penalise the Board; 4

6 review business cases that seek public financing for investment purposes; use long range planning and coordination across units; and monitor the behaviour of monopolies and consider the use of mechanisms such as regulation of pricing decisions on the basis of a transparent formula, threats of regulation, and competition authorities. Public enterprise objectives and autonomy 19. It is the government, as owner, which needs to set clear and attainable objectives compatible with the commercial operations of public enterprises. A Corporate Plan can be a useful management tool in providing an analysis of the operating environment, and enunciating the enterprise s goals and strategies for the future. It is important to clarify the base objectives and operating principles of all public enterprises so these can be translated into quantified and monitored targets. These objectives need to be supported by programs and activities reflected in the annual budgets and investment projects. 20. The social objectives of public enterprises are often the greatest cause for concern. Not because there is anything problematic in an enterprise having social objectives (such as providing access to telecommunications facilities for remote users at an affordable price), but because of the unintended perverse effects of way in which these have been pursued in the past: if the output of a public enterprises is sold below cost the result is deficit and debt, growing shortages, distortions in investment decisions and the waste of scarce resources. These effects can create bottlenecks in the economy. In some cases the benefits of the subsidised prices may not reach their intended beneficiaries or may benefit a much wider group than intended. if the government imposes social objectives and fails to provide appropriate offsetting transfers enterprises are forced to cover the cost through borrowing or eating up their capital stock, deferring maintenance and replacement investments. The real cost of social welfare programs is also covered. the costs of social objectives are typically borne by taxpayers and if the tax system is regressive then the net effect is to worsen income inequalities. less than transparent costs of meeting social goals can be used to cover up poor public enterprise performance. 21. It can be politically difficult to dismantle the social programs and objectives of public enterprises in the short run. Reform efforts should, in the first instance, make social goals explicit, calculate costs carefully and directly finance the added costs through the budget. Box 1 presents a practical example of how this is done in the Cook Islands. Such transparency allows the costs to be weighed against the benefits to develop more cost effective ways to meet such goals and to ensure public enterprises are not decapitalised. Agreed indicators of performance should then be monitored carefully to try to keep any offsetting transfers from eroding efficiency. Box 1: Clarifying Social Objectives 5

7 In the Cook Islands statutory corporations (Airports Authority, Ports Authority and Te Aponga Uira o Tuma Te Varovaro) are wholly owned subsidiaries of the Cook Islands Investment Authority. These all publish annual Statements of Corporate Intent which specify social obligations and their costs, for example: The Airports Authority provides a domestic fire service for Rarotonga (NZ$200,000 annually), and cross-subsidises Aitutaki Airport from Rarotonga Airport earnings to the value of NZ$200,000 annually. The Ports Authority provides public access to and use of its port facilities which has a commercial value of NZ$250,000 annually. Te Aponga Uira o Tuma Te Varovaro provides street lighting in Rarotonga at an annual cost of NZ$160,000. Source: Cook Islands Investment Corporation (2003) Relationships between Ministers / Board and Board / Management 22. Good corporate governance and management of public enterprise requires the separation and clarification of the powers and responsibilities of ownership, governance and management in public enterprises: ownership belongs to Government; governance is the responsibility of the Board of Directors; and management is delegated to the Chief Executive Officer and a team of officers. 23. Corporatisation separates these roles by creating an independent legal identity for the enterprise either as a public corporation or a public company. However to overcome the principal-agent problem (where the manager may not be relied upon to act in the owners interest) when granting autonomy to the manager of a public enterprise it must be matched by effective control, monitoring and reporting mechanisms that make management accountable. This arrangement creates an arms length relationship between government and public enterprises that helps guarantee fairness, accountability and transparency 24. The wide scope of public sector activity gives rise to potentially serious conflict of interest where Government has regulatory responsibilities to the general public for the safety of services and is also engaged in operations in the sector through its ownership of public enterprises. Care is needed to define and keep separate the pursuit of these conflicting interests. 25. There also needs to be a clear understanding and separation of the roles of government, as owner, and the Board, as the public enterprise executive. Political interference in the decision-making and running of public enterprises causes suboptimal decision making and hence reduced performance levels. Political interference also dilutes the accountability of the Board, as the Board cannot be held accountable for outcomes they have not generated. There needs to be in place clear rules and procedures for government involvement in decision making. Box 2 sets out an example of the role of a public enterprise board, and includes the flow of specific information to government and the public. 6

8 Box 2: The Role of a Public Enterprise Board A Board would normally oversee a continuous planning and management process within a public enterprise, preparing and monitoring strategic and annual plans, ensuring that foreseeable risks are identified and seeing that they are managed, as well as safeguarding the financial and other assets of a public enterprise. A Board would also normally expect to: Exercise particular care to see that annual reports and audited accounts of public enterprises are prepared and presented in accordance with the establishing statute and the provisions of the relevant act/ordinance/regulation. Ensure, through competitive recruitment, continuing supervision, and succession planning, that honest and competent executive and senior management is always in place. Ensure that meetings of the full board are held at designated intervals (e.g. at least once every three months). Ensure that systematic and timely preparation and distribution of board papers, minute of board meetings, recording and dissemination of board decisions, reminders on action to be taken, and reports on implementation. Ensure the declaration of interest, withdrawal from discussion, and abstention on voting on any matter by a board member whose interests are or may be effected by any matter. Provide for the use of Board Committees, including but not limited to finance and audit committee, to pursue and oversees specific issues assigned to them by the full board. Ensure that board meetings are conducted in a timely and businesslike manner to avoid unnecessary costs and to set an example of productivity to public enterprise staff and employees. See that the affairs of the public enterprise are promptly, transparently, and accountably reported to the Government, parliament, and the people by the publication of annual and ad hoc reports and new releases. The responsible minister(s) should be promptly informed of any situation beyond the board s control that prevents compliance with the directions and requests of the minister(s). Source: ADB (2002b) 26. It is also important to reduce any perceived need for government to become more actively involved in public enterprises by ensuring the transparent selection of managers capable of operating a commercial venture independently, giving these managers greater autonomy over the operation of the public enterprise and promoting a focus on performance, and adequately compensating them. Management quality determines whether corporate objectives are achieved. Accessing quality management can be problematic in the smaller Forum island countries where there is a limited pool of expertise and also limited financial resources that restricts access to the international labour pool. 27. In Vanuatu, prior to 1998, politically motivated intervention in the operations of public enterprises had been the norm - political appointments to the Board and senior management were often at the expense of effective operation of the enterprise. However following the costly bailout of the Vanuatu National Provident Fund and with the implementation of the Comprehensive Reform Program legislation was passed which limits the degree of political interference in the operations of public enterprises. Public enterprises now have professional board members with clearly defined roles. 7

9 28. Many FICs seek to over come limited human resources (and in some cases keep the government hand on the tiller) by placing senior civil servants from line ministries on public enterprise boards. However, this raises the potential for serious conflicts of interest given the responsibility for policy formulation and regulation on one hand and the need to maximise shareholder return on the other. Accountability can be hampered by the shortage of qualified and experienced board members who are not current or former government employees. More suitable board members may be found in the private sector or be brought in from overseas. 29. A further difficulty in Pacific public enterprises is that of familial relationships among participants in the governance system. However, separation of powers and delineation of roles in a good system of public enterprise governance helps overcome the concerns this may raise. 30. One approach to solving difficulties in the relationship between the government and the board is to create buffers between them. These buffering mechanisms can take various forms such as central oversight organisations or a holding company structure to group a number of public enterprises together and are discussed further below. 31. The longer-term solution to all these problems of political interference and conflict of interest for board members is the complete withdrawal of the state from what are currently public enterprises. Such divestiture is discussed further below. Regulating and monitoring public enterprises 32. Active external supervision and oversight of public enterprises is essential to ensure the sound investment of public money, to ensure financial management and reporting requirements are met, and that government policy objectives are being achieved. Competition policies promote efficiency by preventing practices or mergers of firms that would reduce national welfare through the exercise of market power and are becoming an important oversight element. 33. Oversight provides many opportunities to improve the financial and service delivery performance of public enterprises, provides early warning of emerging problems and any need for budget funds, helps the government provide appropriate support via strategic investment or pricing decisions, and enhances the incentive to perform. It can also help guide public enterprises in terms of what the government expects them to achieve. 34. Oversight is also important in working towards creating the conditions which are considered to make the private sector operate efficiently. However public enterprises tend to operate in an environment very different to this: non-competitive, or monopoly markets; objectives inconsistent with profit maximisation; and government intervention in operations/management. 8

10 35. There are many differing ways in which government chooses to oversight public enterprises, thus regulating activities, monitoring and measuring performance. Sometimes even simple reforms to the system of oversight could substantially improve the performance of many public enterprises and raise their contribution to the economy. 36. Government has frequently played a role in regulating the prices of goods and services produced by public enterprises, especially in the case of utilities where universal public access to water, electricity, telecommunications has been a policy objective. However in some cases this has had unintended negative effects such as decapitalising the public enterprise or placing financial pressures on government to subsidies public enterprises. 37. To overcome this, and the other insidious problem of cost-plus pricing which weakens incentives to reduce costs, government needs to consider: that the regulation of pricing decisions in monopolies be on the basis of a transparent criteria and formula to represent a reasonable level of profit on justifiable costs and be vested in an entity free of arbitrary political influences and with the technical competency to review tariff decisions; the move should be made to market pricing wherever possible; both prices and costs need to be tackled to promote efficiency. 38. Oversight involving line Ministries and the Finance Ministry is a common situation, and allows the combination of important policy skills from the line agency and the financial skills (and concern for the budget bottom line) of the central finance agency. Nonetheless this can result in an unavoidable conflict of interest - potentially biased advice on divestiture, investment and expansion and the promotion of intervention by line agencies. 39. Forum island countries tend to place heavy emphasis on the involvement of their Finance/Treasury Ministries in oversight for example Samoa s state owned enterprises monitoring unit and Vanuatu s Government Business Enterprise Unit. Some exceptions include Fiji s Ministry of Public Enterprise and Public Sector Reform and the Cook Islands Investment Corporation. They have also tended to colocate regulation and monitoring functions, and while in some instances sector specific regulators (eg telecom regulator) have been considered the small skill base in FIC economies hampers this. Indeed the administrative cost of the regulatory regime can be high and may strain the capacity of government. 40. For most public enterprises effective supervision will require that ultimate responsibility rests with a separate agency (although both the line ministry and the public enterprise itself should of course have some involvement in the system of supervision). Such a system of independent supervision would enhance the accountability of public enterprises by providing more information to parliament and the general public on their activities. 41. The separate agency could be: an expanded Auditor-Generals Office with the skills to undertake performance audits and reporting to the Public Accounts/Public Expenditure Committee; or 9

11 a new independent agency reporting directly to Parliament; or a central public enterprise organisation. 42. A central public enterprise organisation can be most effective if it is not overstaffed, has high level links to government (reporting perhaps to President/Prime Ministers Office or to a Cabinet Minister) to provide credibility, a clear mandate and decision-making powers. Care has to be taken to avoid self-interest in advice on divestiture, investment and expansion, and to overcome potential difficulties caused by a lack of detailed knowledge of the sector and the addition of a further layer of control. 43. Whatever system is selected, there are a number of elements which could be considered for inclusion: a code of governance for enterprises; the adoption of service agreements with clear and specific performance targets prescribed; and the undertaking of performance audits, in addition to the traditional financial audits. 44. Negotiated service agreements can be important mechanisms for supervising and improving the performance of public enterprises. These essentially act as a contract between the enterprise and the government. Such an agreement allows a government, as owner, to reduce its control of day-to-day matters in the knowledge that limits are set on the public enterprise s behaviour and that performance will be checked. Service agreements are considered further in the section on performance evaluation below. 45. A code of governance can provide support for a system of supervision. The code can set out clearly the roles of key parties, and mechanisms for ensuring that each party can carry out its responsibilities. The code could also put into place important principles for all public enterprises, for example with respect to ethical standards, the environment, standards for setting employment terms, and conditions for and payment to board members. 46. Codes can be established as a legal requirement binding on those with a formal role in the system of oversight, or as a policy document with no legal force but used to guide to appropriate behaviour. 47. It is important to recognise, however, that as public enterprises are exposed to competition the level of government oversight can be reduced to allow the enterprise to better respond to market signals. Indeed more effective controls act to reduce the administrative burden on government, which is particularly important where government capacity is limited. Box 3: Example of a Governance Code Planned for the Pacific Samoa s planned State Owned Enterprise (SOE) Act provides an example of a governance code for public enterprises which has been developed in the Pacific. 10

12 Features of the Act are a more precise definition of the principles of corporatisation, a clarification of the role of Ministers, the increase of powers of the State Owned Enterprise Management Unit (based in the Treasury), and an improved system for public reporting by public enterprises. The proposed SOE Act includes: A principal objective for every SOE to operate as a successful business, including an obligation for each SOE to be as profitable and efficient as a comparable private business. A requirement that Statements of Corporate Objective and corporate plans be prepared to document activities of SOEs and that these be tabled in parliament. An obligation that Ministerial directions to SOEs must be tabled in parliament. The provision of increased powers to SOEMU to ensure that SOEs report in a timely manner. An obligation for government to fund non-commercial activities of SOEs. Establishment of shareholding ministries which report to parliament. Provision on the role of directors. Source: ADB (2000) Evaluating public enterprise performance 48. The evaluation of public enterprise performance has traditionally focussed just on financial performance, but significant benefits can be gained through expanding performance evaluation to include indicators of productivity or service quality (including measures of customer satisfaction, public attitudes, employee satisfaction, safety and business growth). These measures can increase public accountability and stimulate improved operation. Without such information from public enterprises government is poorly placed to oversee them and handicapped in responding to a crisis. 49. Service agreements can be negotiated between government and the enterprise. These contractual-type arrangements act to increase transparency and promote the consideration of costs. However, government must be committed to the agreement and they are most usefully developed through the public enterprise s corporate planning process. A preliminary step involves placing emphasis on separating the enterprise from core government, subject to a commercially oriented performance contract or agreement being put in place. 50. The ADB (2002b) has suggested that a service agreement can include statements regarding: objectives, nature and scope of the main activities of the public enterprise; service performance standards; mechanisms for measuring performance against the agreed criteria; the nature of information to be provided to the Government by the public enterprise during the course of the financial year, including information to be included in quarterly and half-yearly reports; required government financial contributions to cover operating and/or capital costs; 11

13 impending major investments and proposed financing arrangements; proposals for varying the Government s equity contribution; the public enterprise s dividend policy; terms of access to and use of land and other fixed assets; pricing policies (eg tariff structures and amendment procedures) in cases where a public enterprise lacks effective competition; accounting policies to be applied; specific employment, wage and industrial regulations requirements not reflected in general legislation; mechanisms for periodically revising the service agreement; and such other matters as might be agreed on by the shareholding ministers and the board from time to time. 51. To evaluate the performance of a public enterprise it is necessary to clarify the factors responsible for its performance, and distinguish between those factors that the enterprise can be expected to control and those it cannot. For example, poor financial performance may have more to do with externally imposed constraints than the quality of management; or an enterprise may be poorly run and inefficient but still show a profit because it can take advantage of a monopoly position. 52. Performance evaluation requires timely and good information concerning specific criteria for evaluation. These criteria should reflect targets and in turn agreed objectives. For quality financial performance information it is necessary to have internal management information systems, to improve auditing standards and streamline and standardise reporting relationships. 53. When public enterprises face effective competition from the private sector (and compete on similar terms without any unfair competitive advantage) the key performance criteria should be profitability as indicated by the public enterprise s return on assets and return on equity. If similar returns are earned to the private sector it is reasonable to assume the public enterprise is operating efficiently and setting appropriate prices/charges. 54. It is vital that financial information on the performance of public enterprises, in the form of audited accounts, is available in a timely manner. As shown by the 2004 FEMM Biennial Stocktake (FEMR.06) Auditors General in the Pacific are frequently hampered by lack of skilled human resources and the implementation of their recommendations can be delayed by insufficient parliamentary consideration. However many countries are making efforts to reduce these constraints. It is important to ensure follow-up by boards and management of the public enterprises to adverse findings (indeed this is the case for non-financial performance measures also). Repetition from year to year of adverse findings on the same matter and a high incidence of qualified audit opinions indicate this is not always occurring. 55. When public enterprises have monopoly power, in at least some aspects of their business, profitability alone is not a sufficient measure of performance. Indeed, 12

14 some monopolies are unlikely to earn profits because they have an obligation to undertake activities that are not commercially viable or have constraints on pricing. It is important to set performance criteria based on service standards and efficiency, for example: require a set percentage increase in physical performance indicators each year; prices could be allowed to increase at the inflation rate less x%; or performance criteria could be set based on international benchmarks or an assessment of the enterprises productivity. 56. Associated with improved measurement of public enterprise performance is the need to provide incentives for the achievement of these through holding managers responsible for results. Managers and staff can be rewarded (or sanctioned) on the basis of performance. In many FICs implementing such a system needs to overcome the common perception that a government job is a job for life and instill a commitment to work obligations and problem solving. Culturally, tackling nonperformance (or even singling out outstanding individual performance) can be problematic and these difficulties may best be overcome by ensuring a transparent system of assessment, including an appeal process, to ensure such decisions are fair and fully understood and accepted. Review financing decisions that affect public funds 57. There are a number of issues that emphasise the importance of a focus on the financial performance of public enterprises. 58. Indeed a common problem in the Forum island countries has been the government tendency to bail out public enterprises which have got into financial difficulties, in the face of sometimes negative returns on public funds invested and the broader economic impacts of diversion of these funds into seemingly unproductive purposes. 59. Governments need to be cautious of injecting new equity into cash-strapped public enterprises without assuring management will not treat this as a costless bailout. The public enterprise needs to be profitable to its equity or else a capital injection acts the same as a subsidy without the transparency advantages of a subsidy. In many cases a subsidy can be a better approach as this can be reviewed annually and reappraised. 60. Furthermore, in the case of government entering into loan agreements or guarantees it is essential that parliament/congress is fully informed of, and understands, the longer term implications. This is particularly so when these are entered into on behalf of public enterprises. This is the fourth of the Forum Eight Principles of Accountability, and while FICs are making implementation efforts it is an issue to which it is worth paying renewed attention. 61. Financial management by public enterprises also needs to be put on a sustainable basis if it is to be considered sound. Capital investment programs need to be supported by asset management and maintenance systems. There are many examples in the Pacific of public enterprises that have ignored maintenance of 13

15 infrastructure assets out of operating income in favour of buying new assets with external financing. 62. Finally the use of subsidies to support the non-commercial services of public enterprises must be adequately monitored to ensure these are set and implemented transparently. Sequencing public enterprise reforms and divestiture 63. Clearly getting the essential goods and services produced by public enterprises most cost effectively is a concern to Forum island countries. In an effort to ensure this, FICs have undertaken various reform programs, which in some cases have also encompassed commercialisation, corporatisation, strategic partnerships between the public and private sectors, management contracts, partial privatisation and full privatisation. In cases of severely under-performing public enterprises liquidation and suspension of operations has occurred 64. Divestiture of public enterprises aims to enable a manageable size public sector, better utilise the capital, improve efficiency and encourage innovative management, and encourage private sector activity. Divestiture can also act to raise revenue for government and to reduce fiscal and credit pressures on government. 65. Public enterprise governance reforms are intrinsically linked with competition principles in a market regime. As progress is made to more open regimes the broader and stricter observance of competition principles is as essential as the pursuit and implementation of public enterprise governance reforms. Good public enterprise governance also results in a better investment environment. 66. Competition is promoted through the break-up of monopolies, reduction of trade barriers, encouragement of exports (for example Fiji Shipbuilding), and elimination of barriers to private entry (thus creating contestable markets for monopolies). There does not have to be a competitor for the threat of potential competition to make a single provider alter their practices and offer competitive service prices and quality, indeed in some cases such single firms may prevail because they are efficient. Market proxies can also be sought where competition is not possible, for example publication of service indicators. 67. It is necessary to prepare prioritised, sequenced and time bound divestiture plans. Additionally the administrative costs involved in reform should be considered some areas may offer gains too small to warrant attention initially or to prioritise ongoing reforms. For example, ADB (2000) noted that Samoa s then plans were to continue the privatisation of the partly-owned enterprises (total value of these is only SAT$7million as compared to SAT$400 million invested in the fully owned public enterprises) rather than the fully publicly-owned enterprises. Furthermore the partlyowned enterprises were on average profitable as opposed to the public enterprises which had an average negative rate of return. 68. A comprehensive approach to public enterprise reform is central to the success of structural adjustment in economies where the sector is highly influential. Policy issues such as pricing, labour, trade and finance are particularly pertinent to public enterprises. Such an approach is the best way to ensure that public enterprise reforms 14

16 are coordinated with changes in macro-policy and to conserve on scarce administrative skills. When divestiture is the intention it should be part of a broader program of reforms designed to promote a better allocation of resources, encourage competition, foster a supportive environment for entrepreneurial development, and develop the capital market that is to allow the development of the private sector as a replacement to public enterprises. 69. Theory indicates that any commercial enterprise, public or private will function most efficiently when it strives to maximise profits in competitive markets under managers with the capacity, autonomy and motivation to respond to market signals and when enterprises which cannot compete go bankrupt. Public enterprise reform has often set out to create a competitive environment through: corporatisation and commercialisation; introducing performance contacts with private sector managers or entering into management contracts with private sector operators; putting government subsidies out to tender which creates the beneficial price discipline of competition. Providing the tendering process is made clear and simple, such an approach could avoid the need for a government run operation shipping and aviation are two clear candidates; unbundling of utilities through creating open access to the transmission channel; partial privatisation, such as in the case of the Tonga Telecommunications Commission and the International Dateline Hotel, Tonga; and full privatisation, such as in the case of power generation in Tongatapu, Tonga. 70. Any reform runs risks. Even when undertaking corporatisation and commercialisation care must be taken to avoid: a negative impact on the national budget (especially given the narrow revenue base of the public sector) as a result of loss of income from the enterprise as any profits made by the enterprises are now often retained for investment. the use of the reforms as a means of paying higher salaries to public sector employees, rather than a means of improving performance. 71. Whatever mechanism is chosen, the divestiture of public enterprises has to be carefully managed so as to ensure the minimal revenue impact on the budget while maximising economic efficiency (and gains to society). In particular, the risks of transferring monopolies from the state to the private sector must be carefully planned. 72. A prerequisite for the divestiture to result in competitive pricing, particularly of services from natural monopolies, is to have in place the regulatory structure and enforcement mechanisms that induce competitive pricing. A legislative framework for regulating the relationship between public enterprises and government is needed. Such a platform needs to be in place before any state assets are transferred to the private sector; an issue not fully addressed to date. 73. Public enterprises operate in many sectors where private business could successfully operate under the right conditions, such as the provision of electricity, 15

17 water and telecommunications. Unbundling utilities allows private sector access to the transmission channel (pipe, line or cable) to be determined using pricing and/or quantity (capacity) mechanisms. Payments to the monopolistic supplier of the distribution channel may be determined by a regulated rate of return on assets or by price controls. With unbundling the activities of pricing, setting customer service standards, dispute resolution, setting environmental standards, and meeting social obligations also become separate. 74. It is difficult to justify the continued retention of public enterprises that operate in well-developed competitive markets without a clear social rationale for their operation. Competing with the private sector has been promoted as a way of keeping prices down and generating benefits for consumers and the economy. However, in practice while there is some anecdotal evidence of reduced prices, this may also reflect a playing field favourably directed to the public enterprises and depression of earnings throughout the sector. In this situation an inefficient public enterprise that does not have to compete to stay in business may actually raise average prices. 75. If public enterprises are to operate efficiently and the private sector is to be given a chance to develop, even in competition with public enterprises, then there is a need to address factors which discriminate in favour of public enterprises at the expense of private enterprises (to ensure competitive neutrality): access to government subsidies, loans and guarantees, tolerance of arrears on taxes, favoured position in public procurement decisions. 76. It is equivalently important to also ensure that public enterprises are not unduly constrained by their position of public enterprises and are able to compete on an even footing with private companies: Directors are not conflicted in their positions; managers have business skills; use of layoffs and closures; ability to set appropriate wage and salary levels; appropriate capital base; and able to collect from creditors. 77. Frequently divestiture is most successfully carried out through a central administrative unit which has the requisite skills. Indeed, public enterprise reform requires a range of specialised expertise and usually proves more time consuming than envisaged at the outset. Conclusion 78. Forum island countries have a demonstrated commitment to public enterprise reform. Improved corporate governance of public enterprises is important to the overall equity and competitiveness of the economy. The important economic and 16

18 social benefits of a well-planned reform program which maximises the value of government investment and accountability for activities are understood. 79. To improve the efficiency of public enterprises there needs to be: application of hard budget rules (including re-evaluation of the reliance on equity and capital injections, as these can be counter-productive to efficient ongoing operation); tying of subsidies to specific non-commercial services (and tendering of these where possible); more detailed, and publicly available, definition of corporate goals and enforcement of governance standards; operational autonomy for public enterprises; the definition of clear roles and responsibilities for Government (as owner) and Board/managers; the setting of clear performance objectives (eg rate of return) and measures or targets against which Boards can be held accountable; opening up to competition in areas of interest to private sector; a level playing field between the operations of public enterprises and the private sector, so both operate on an equal footing; strengthened performance monitoring and public reporting; and steps taken to improve the quality and skills of public enterprise managers, particularly as they are given greater autonomy. 80. Government needs to re-evaluate the use of injections of equity and capital into public enterprises, as these can be counter-productive to efficient ongoing operation. Furthermore government also needs to reassess the social service demands on public enterprises, and ensure these transparently identified and are directly funded from the budget. Finally government needs to minimise their involvement in the dayto-day operations of public enterprise through the definition of clear roles and responsibilities for owners and managers the use of buffers such as holding companies could be considered. 81. Commitment to comprehensive public enterprise reform is vital to ensure its success and can be enhanced through such actions as the following: identifying winners and losers in the reform process and working to build understanding of and commitment to reform through workshops, seminars and the structure of project leverage; balancing the long term nature of public enterprise reform with the politician s short term framework by building in quick payoffs and focusing on actions where prospects for success are high; and strengthening public enterprise regulation and oversight agencies. 17

19 Pacific Islands Forum Secretariat, Rotorua 10 June

20 References ADB (1999a) Republic of the Fiji Islands 1999 Economic Report, Pacific Studies Series, Manila. ADB (1999b), Pursuing Economic Reform in the Pacific. ADB (2000) Samoa 2000, Pacific Studies Series, Manila. ADB (2002a) Cook Islands 2001 Economic Progress Report: Policies for Progress, Pacific Studies Series, Manila. ADB (2002b) Kiribati: Monetization in an Atoll Society Managing Economic and Social Change, Pacific Studies Series, Manila. ADB (2002c) Tonga Natural Resource Use and Sustainable Socioeconomic Development, Pacific Studies Series, Manila. ADB (2002d) Vanuatu Economic Performance and Challenges Ahead, Pacific Studies Series, Manila. Cook Islands Investment Corporation (2003) Statement of Corporate Intent for the Three Year period 1 July 2003 to 30 June Duncan, R., S. Cutherbertson and M. Bosworth (1999) Pursuing Economic Reform in the Pacific. Chapter 6 Competition Policy. ADB, Manila. Knapman, B., Malcolm Ponton and Colin Hunt (2002), Tuvalu 2002 Economic and Public Sector Review, Pacific Studies Series, Manila. Republic of the Marshall Islands (2001) Meto2000 Economic Report and Statement of Development Strategies. Shirley, M. M. (1989) The Reform of State-Owned Enterprises: Lessons from World Bank Lending, Policy and Research Series 4, World Bank, Washington. 19