If it’s broken, IT can’t fix it

Schumpeter, the Economist’s business contributor, appears not to understand government. His recent article, Fixing common affairs, suggests why. The article implies that by harnessing the power of IT, government can become more efficient.

Government tries to harness IT’s benefits, they just do it badly.

The introduction of IT only mechanizes the processes, when there isn’t a simultaneous redesign of the existing controls. With mechanization the quality control sample is reduced to two (n = 2). By testing the first item in a batch, and the last item in the batch, when both samples meet the production standard, one is sure that the complete batch meets the production standard. But if the production standard is poor, mechanization won’t improve it.

When systems are not integrated, it requires human intervention to get controls to work. If a payment system requires that the person doing the authorization has had a specific training, integration with the training system should confirm that automatically. If the systems are not integrated, it requires that a second person checks the authority levels, and in the event that the person does not have the necessary authority, sends an email that the authorization is invalid until the course has been taken. Then, when the course has been taken, a second chain of emails needs to be sent, so that the payment can be made.

This goes to the heart of the difference between procedures and systems. Procedures simply provide evidence that something has been done. Systems ensure that what should have been done has. In a properly designed system the end event taking place proves that all the intermediate steps happened.

Sometimes reconciliation to external data is necessary to ensure that all the transactions have been correctly recorded. For example, in an accounting system the bank reconciliation checks that all transactions in the cash book appear in the bank statement, and all the transactions appearing on the bank statement have been recorded in the accounting system, and that any differences can be explained. Without the reconciliation there’s no guarantee that all transactions have been recorded.

Without these systems and complementary controls IT can’t change anything.

Sometimes IT makes things worse. Take the reply-all button. People who work in government will tell you that two days away from the office will result in an inbox with hundreds of emails. Fighting the tide becomes the dominant task on return to work. That’s hardly productive.

Many of governments inefficiencies can be also attributed to the complexity of the management structures and unbridled ambition.

There far to many layers of management and matrix structures, where people at lower levels are accountable to two or more bosses, are a norm. The inefficiencies that matrix structures create are the reason why business schools teach that they should only be used as a last resort.

The ambition that runs rampant in government creates a situation where bad news is concealed to avoid the possibility that it will taint a golden career. Schumpeter in his article “Fail often, fail well” describes how Alan Mulally, on taking up his tenure as Ford  CEO, discovered that although the company was in crises, executives were unable to admit to having any failures. Once managers learned to admit that things were going wrong, and to invite help, the company turned around, and was the one motor manufacturer that did not require rescuing in 2008 when all the others were bailed out.

Having seen some well written fiction in government reports makes this correspondent believe that the same medicine would go a long way towards making public institutions a lot more efficient.

Government must work smarter, and when that happens, IT will help.

More at:
Fixing common affairs
Fail often, fail well

The governments’ ponzi scheme

With ponzi schemes, the golden rule to avoiding them is: “if it sounds too good to be true, then it is too good to be true”.

Current investors funds are used to provide remarkable returns to the early investors, so there’s a credible track record. It needs to keep growing to keep paying. As soon as there aren’t enough new investors, the scheme sensationally fails. People who’ve invested discover too late that the money just isn’t there.

And so it is with the pensions of public servants.

The contributions are based on the salary earned at the time. The pensions are calculated on the salary in the last few years. The calculation of the amount that expected to be paid at retirement is based on the life expectancy, and that’s gone up. So where does the missing money come from: current contributions.

Pension schemes are supposed to calculate their liability to make sure that they have funding. The pension payments are in the future. A payment in the future is not the same as a payment today. One hundred dollars today is worth more than one hundred dollars in 10 years time. Accountants and actuaries calculate today’s value of the future payments using a discount.

An amount of $100 in 10 years time at a discount rate of 10% is worth $38.55 today. At a rate of 1%, it’s worth $90.53. The rate makes a big difference, and if it’s wrong, the value can be badly out. The rate used should be a reasonable estimate of the expected return that could be earned on the current investments. With the current climate, and a very low risk free interest rate, the expected return can only be low. The figure of 8% that the funds are using bears no relation to reality.

Because of this, a number of towns and cities have started to declare bankruptcy. Stockton is the biggest so far.

The OECD has done an exercise predicting the picture for member states in 2060. They estimare that by then four countries will have a shortfall amounting to more than 10% of GDP. The worst offender – Greece.

One solution is to up the retirement age. So, one wonders what arithmetical miracle France’s President François Hollande will have to perform to reduce the retirement age to 60.

The cheque is in the mail.

More at:
OECD Pensions Outlook 2012
OECD Shortfall in pension
Stockton’s bankruptcy
Fun with pensions
Ooops, the coffers are empty
The road to risk
Promise now, bill your children

Austerity – what does that mean?

The term austerity has been used a lot of late. It’s defined as “difficult economic conditions created by government measures to reduce public expenditure.”

It’s often made to sound like an unpleasant medicine, which if taken early and swallowed hard, will produce the cure, and all will be well. That really is an over-simplification. Producing a cure requires an accurate prognosis, and the appropriate medicine. Explaining to the patient (the voters) what could happen if the disease remains untreated is also a good idea.

Simply reducing expenditure is not the solution.

South Africa provides a number of useful examples. In the early 1980s, the recession and economic uncertainty in the rest of the world caused investors to take refuge in Gold, South Africa’s biggest export commodity at the time. The Gold price rocketed, and while the rest of the world suffered, the South African economy boomed. The success had nothing to do with anything the South Africans were doing right, and a sensible government would have invested the money into building a competitive economy. Instead it did the opposite.

Faced with a strong currency, South African manufacturers asked for protective tariffs, and the government obliged. Instead of learning to compete, and letting the citizens of the country benefit from the financial windfall brought by cheap imports, South African manufacturers developed the habit of looking for protection. They became less and less competitive and some industries eventually withered and died.

Education, one of the best long term investments a country can make, was also suffering. A generation’s education was lost demonstrating against the scourge of apartheid.

Greece, Italy, Portugal and Spain all have industries that are protected. Their economies are becoming less competitive, even as the developing countries are reaping the benefits of their investments in education, and are challenging in markets once dominated by the developed world. The changes that the IMF and Germany have insisted on include removal of the protection of vested interests. The resistance from the powerful lobby groups was to be expected. The governments’ failure to explain that they were complicit in creating the economic imbalances has made the situation worse.

The Portuguese are quietly fixing things. Italy, under a technocratic government, was making good headway, but has recently hit resistance. Spain, with a plethora of challenges is triaging.

So, austerity becomes an easy catch-all phrase, and when the whole economy suffers, the interest groups motivate the uninformed electorate to rebel. They have. The outcome of the Greek polls, and the expected vote for a government with little understanding of the cure required is symptomatic.

The sudden European funding of the banks in Spain provides a hint that a Greek exit is expected soon.

The financial hardship that the Greeks will suffer will be unfair. But perhaps it will provide an incentive for the protected interests in Italy and Spain to prevent the same from happening to their fellow countrymen.

A better form of government?

In an earlier rant I suggested that the current form of democracy is an anachronism. So what?

In 1945, while he was attending the Potsdam conference, Churchill was voted out of power by the British electorate. The Potsdam conference was one of the most influential meetings of world leaders, attended by Churchill at the beginning (followed by Attlee), Truman who had succeeded FDR, and Stalin. The agenda was how to divide Germany and Austria between the powers, and the strategy to end the war with Japan. At the time, Stalin armed with intelligence gathered from spies within the Manhattan Project knew more about America’s nuclear weapons than did Truman. It was not opportune to lose the continuity of leadership. The British electorate thought otherwise.

In 1947, Churchill commented that “democracy is the worst form of government except all those other forms that have been tried from time to time”, as leader of the opposition making a speech in an attempt to prevent Attlee from disbanding the House of Lords.

Four years later the British public, perhaps appreciating the error that they had made, re-elected Churchill.

Already in 1947 Churchill understood that a better system of government in an increasingly complex world had become necessary. Now, 65 years later there has been little improvement.

So what would be better?

Firstly, if the people in government are qualified to do the job, perhaps they would do it better. Politicians are professionals at getting elected, not doing the job that they are elected for. The people running the government should be qualified to manage in the specialist roles: economics, finance, law, justice, education, defence, policing, tax, social services, communication, information technology, transport, energy, medicine and health, agriculture, mining, banking, art, history, and management.

Once the necessary qualifications have been obtained, the professionals would need to serve an apprenticeship, working with and supporting practising experienced professionals.

Then, after having served the apprenticeship, the next step is graduation to a professional consulting role, analysing working professionals and advising them on strategies that can resolve the issues that they face.

Respected consultants can then be promoted to junior roles in practice, where they themselves face the daily challenges and the responsibility of developing and implementing solutions. Candidates that establish a successful track record are promoted to higher responsibilities, while the less successful go back to consulting, or perhaps some other career.

Of course there are some practical issues. Where do the qualifications come from? Who sets the standards for the qualifications? Which organisation will manage this? Who appoints the professionals? How is their performance measured? Why would the existing politicians accept this change? Why would any country accept this change? Who pays?

This would ordinarily be a responsibility of the UN – but there are reservations. The functionality of the UN is something that William Shawcross in his books “Deliver us from Evil” questions because the Security Council is divided in principle. That won’t work.

So, if not the UN, who?

An alternative is the European Union – as an experiment to help some of its distressed members, as well as the potential candidates for membership.

To instigate the appointment of this government in any country, the electorate would have it as an alternatives to the other candidates on the ballot in an election. If elected, the voters can call for the system to be terminated by way of a referendum, which happens every five years (say) or if sufficient voters (say 5% of the registered electorate) call for one.

As soon as governance is established as a profession, the leading universities will respond to the demand from prospective students. The standards for qualification should be set by a professional body, as is the case with most other professions.

Initially, the EU will manage the process, with the intention of allowing it to devolve into an internationally recognised independent body. This same body will propose the candidates for various positions in the country. The country represented by an elected “Senate” will have the authority to select candidates from among those that are proposed by the International Body.

Measuring performance: growth in GDP, level of trade, (lack of) International conflict, (reduction in) crime rates, education performance, health, infrastructure, efficiency of transport, energy composition and supply, efficiency of government are all measurable and comparable with both past performance and the performance of other countries.

Existing politicians might be obliged to accept change as a condition of acceptance into the EU, or for financial support, or because the electorate demand it.

The electorate would want it because, once proven, it is seen as a better option to what is already on offer – in many countries it would be an easy choice.

Who pays – the country should, as they do now.

Some other thoughts – the government should not have the authority to declare war. That is under the control of the International Body, which also supplies the manpower, weapons and expertise.

Similarly the police and justice departments fall directly under the control of the International Body. This to prevent coups, and to get the benefits of scale.

Most importantly, the professionals have continuity, and their goal is promotion to a larger country, and higher pay and more prestige. Large countries will have proven leaders. Small countries will have leaders determined to succeed, so that they are promoted to lead the bigger countries. Leaders that don’t meet expectations will be dismissed.

Corruption, nepotism, and conflict become less likely.

Utopia – not by far, but it forms the framework for something to build on.

More at:
Technocrats Minds like machines

Government of the people, for the people, by the people!

Events since the start of the financial crisis in 2008 have been revealing. Politicians are being exposed for serious errors in the past and are ill equipped to provide solutions for a world in distress. This is the first in a series of discussions about why politicians are unsuited to manage, and suggestions as to how that can be fixed.

It’s common knowledge that one of the primary causes of the crisis was the crash of the sub-prime market, and the focus for the blame has been the “big banks”. And, while they continue to collect astronomical bonuses, senior executives of the big banks say that the fault lies elsewhere. Ragharam Rajan, in his book “Fault Lines” argues persuasively that the bankers may have a case, and that politicians seeking re-election are also at fault.

The growth in the disparity of wealth forms the foundation of Rajan’s argument. In 2007 23.5% of all American income flowed to the top one percent. The earnings of the top 10 percentile increased by 65% more over the period 1975 to 2005 than the wages of the other 90%. That the majority of voters has not benefited from the income growth in America encouraged politicians to intervene.

Simply put, economic data shows that the country is getting wealthier and wealthier, and that wealth is mostly concentrated in the hands of a select few.

So, to create the appearance of wealth, the solution for the politicians appeared in the magic of finance. If mortgage rates decline property values increase.

Let’s see how that works. On a $100,000 loan, If the mortgage rate is 12%, the repayment will be a little over $1100 a month, and the total interest paid over a 20 year mortgage amounts to more than $164,000. When the mortgage rate drops to 2%, the repayment drops to $505 a month, and the total interest over the period of the loan is a more reasonable $21,400. People who need to borrow money to purchase their homes look at the affordability of the monthly repayment. As interest rates drop there is more money chasing the same number of houses, and property values increase. The increase in house values encourages some people to buy new homes, and others to borrow against the increased value of their existing property. People have an increased sense of prosperity, founded on an illusion.

The increase in house prices lags behind the drop in interest rates by a number of months, sometimes years, and so improved affordability also affects those who have never owned their own homes, including the sub-primes.

At first the sub-prime market was very attractive. The new borrowers with little credit history attracted higher rates of interest (but not so high as to impact affordability) in recognition of the greater risk of default. But in the minds of the bankers, these loans were secured against properties, the values of which were increasing, negating the perceived increased risk. Showing massive returns, the market grew exponentially, attracting investors from all over the world. That was fine while property values increased.

Then economists started saying that it was unsustainable. And as Herb Stein said, if something cannot continue, it won’t.

The markets froze. The banks stopped lending to each other, and suddenly there was a liquidity crisis. Lehman Bros failed, and the potential for a widescale bank run seemed imminent. The Federal Reserve stepped in and the initial crisis was averted.

But the cat was out of the bag. Stock markets and property prices around the world crashed. Economies, especially those in the developed world, went into recession.

Then another financial fiction was exposed. For risk purposes the countries making up the Eurozone had all been given the same credit rating. The cheap funding encouraged governments to spend lavishly. The responsible governments contained borrowings, spending mostly on necessary infrastructure improvements. Others wasted money, often buying votes through unnecessary government employment. Greece being the worst example.

Realising that the credit risks of the various Eurozone countries were unequal, the markets reacted. Interest rates for the delinquents rose, and rose. An interest rate above 7% is considered to be unsustainable. Greece’s rose to more than 20%. Analysts confirmed that the country was insolvent and uncompetitive. Constitutional flaws in the concept of the Eurozone prevented both the Greek government and the technocrats in the European Central Bank (ECB) from providing the conventional solutions.

The Euro politicians, led by Angela Merkel, muddled and prevaricated, making a bad situation worse. The politicians were unable or unwilling to suggest the solution: the creation of Eurobonds and empowering the European Central Bank (ECB) to intervene. The solution requires a devolution of powers that the politicians are unwilling to relinquish.

In 1947 Churchill said that “democracy is the worst form of government except all those other forms that have been tried from time to time; but there is broad feeling in our country that the people should rule, continuously rule, and that public opinion, expressed by all constitutional means, should shape, guide, and control the actions of Ministers who are their servants and not their masters”.

Democracy is not a meritocracy. In the 1980s Jackson Browne groaned that “they sell us the president the same way they sell us our clothes and cars. They sell us everything from youth to religion, the same time they sell us our wars.”

Politicians on both sides of the Atlantic have focused blame on each other, rather than developing solutions through consensus. Voters in Greece, Spain, Ireland and France voted for the most popular alternative to the incumbent, voting in untried novices whose policies and solutions, if they exist, are unknown or at best vague.

The accounting principles adopted in the production of national accounts add to the difficulty in developing the solutions. Improvements to infrastructure, especially those leading to capacity improvements are expensed in the year in which they are incurred. In a commercial enterprise such capital expenditure would be allocated to assets on the balance sheet and expensed over the lifetime of the asset. Accounting for improvements in the year they are incurred acts as a disincentive towards what is often beneficial and necessary expenditure, especially in the long term.

The much bandied term of austerity should distinguish between expenditure which can elicit growth, and expenditure which is unnecessary and wasteful. That the politicians dealing with the crisis have not made this distinction suggests that they either do not understand it, or worse, believe that the electorate won’t.

We would never allow the executives of leading corporations to be appointed for their public appeal, like some bad reality TV show, and yet that is how politicians in Western democracies are elected to run the world’s leading economies.

The appointment of world leaders should be based on proven merit. Government of the people, for the people, by the people needs to take a better form.