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Public sector cuts require a private sector axe

GOVERNMENT departments are set for another brutal five years of spending cuts. With the exception of a few privileged public services, such as the NHS and schools, the Treasury is asking departments to model two scenarios, of 25% and 40% savings in real terms, by 2019/20.

This could put finance directors at the forefront of the public sector, and will allow them to shape the strategic direction as they try to minimise the effect on frontline services. But experts are warning that, in order to this, they will need to radically change the mindset of the public sector.

At the centre of such plans will be the role dubbed ‘the government CFO’, who will be co-ordinating the financial management across 17 government departments. So what chance do the new incumbent in that role and public sector finance professionals have in meeting these challenges?

The spending review

One thing we do know is that these challenges will be tough. The review – one of the Conservative government’s first moves since seizing power on its own – revealed that the austerity programme would accelerate now that the apparent brakes of the Liberal Democrats had been removed. Speaking to the BBC’s World at One, Cabinet Office minister Matt Hancock acknowledged that the programme, with potential 40% cuts, meant ‘radical change’.

The final plans for each department will be announced in November, and the government is obviously tight-lipped about what the individual departments’ draft proposals involved. But the original document, released in July and containing the ambitious targets, also imposed further parameters on departmental plans, including promoting innovation, promoting growth and productivity, promoting ‘radical devolution of powers’, and driving value for money across the public sector. The main message, however, was clear: any damage to frontline services should be avoided.

Of course, the usual suspects for efficiency savings were mentioned. The spending review said that the government had “agreed proposals with all departments to abolish contractual progression pay across the civil service”, while limiting the average public sector pay rise to 1%. In addition, it has “taken strides to reduce the size of its estate, getting out of expensive buildings that it no longer needs, and releasing surplus public sector land”.

But these are fairly traditional means of cutting spending, and CIPFA says departments have already trimmed much of the fat, having made average cuts of 19% between 2010 and 2015.

It adds: “Now that the low-hanging fruit and the opportunity to further salami-slice services has gone, it may be very difficult to achieve further cuts, particularly when the government has ring-fenced funding in some areas, meaning there is a disproportionate impact on others.”

Good financial management

However, alongside the ‘low-hanging fruit’ of pay lockdown and selling off assets, the spending review places particularly emphasis on one area where departments can think differently: good financial management.

It said: “To get the most value from taxpayers’ money, the government will continue with its ambitious programme to improve financial management across all 17 main government departments and arm’s-length bodies.”

To help achieve this, the Treasury has created the role of director-general of public spending, which will “perform many of the functions of the CFO role found in the private sector, but adapted to government”.

In a surprise announcement, the Treasury looked in-house, and appointed Julian Kelly, a long-time Treasury accountant, to the role. The priority for Kelly in his attempts to strengthen financial management is detailed by the Treasury in its plans for the post: “to grow the talent pool of finance professionals at all levels in the civil service”.

Ross Campbell, the ICAEW director for public services, says the government does have people with good financial skills – just not enough. But it can do more with the skill it does have.

“In most cases, the FD now sits on the department board, which is a recent development in the last couple of years,” he says, though he adds: “FDs should not just be accounting for the money and managing the processes. They should be planning the money, understanding the risks and properly advising the board on what they can and can’t do within the financial envelope. I don’t think we are seeing enough FDs in government occupying that strategic role yet.”

With a strengthened FD role, improved financial management will follow. Kru Desai, head of government and infrastructure at KPMG, says that a strong financial management capability “will cut out 20% of the cost with no impact on services”.

One area where Kelly and the potentially newly empowered legion of FDs can make a difference is by improving on systems and processes, says Campbell. The way to make savings would be for the government as a whole to “look at the underlying activities that they do and how they contribute to the policy outcomes they are trying to achieve” as opposed to the “salami-slicing” method of shaving money from each department, says Campbell. He points to services being provided on a blanket basis, “for example, relatively affluent pensioners still get free bus passes”.

But currently, he says, the systems and processes in the public sector don’t allow a different approach.

Campbell continues: “Generally, when the question is asked whether it can be better targeted, the response from government is that it would cost more to target it than we’d save. Why is that? The answer is: because they haven’t actually invested in the business processes and financial management systems over the years – [so that would] be hugely expensive.”

Instead, the government would have to do a vast manual exercise, Campbell adds.

Desai agrees: “I believe that it is still extremely difficult to get intelligent information to support effective decision making. Departments still struggle to answer basic questions about what things cost and why. Offline error-ridden spreadsheets are still endemic but they can be fixed with low-cost smart tech.’

CIPFA defends the systems, pointing out that systems “have improved considerably over the past few years – the quality of the information in particular”, and that it has “identified the outstanding quality of their financial reports and accounts that are even better than those found in the private sector”.
Even Campbell acknowledges that some departments, such as the Department of Business, Innovation and Skills and the Department for Transport, have been leading the way in updating their systems.

But there are other ways in which the director general can help improve the government’s financial management, says Campbell, such as by fully understanding its liabilities – an area where the public sector is currently lacking.

“Yes, the chancellor has been managing down the in-year deficit,” he says. “But when you look at the way the liabilities are growing – particularly pensions, the national debts and also the amount of money provided for things in the future, like nuclear clean-up, medical negligence – they arguably haven’t got a good enough grip on that unrelenting growth in liabilities and they need to focus more on that.”

Looking to the private sector?

The Centre for Policy Studies released a report following the spending review – Tough love for a better future – in which it urged the public sector to look to the private sector in a number of areas, such as having “project leaders whose career depends on success”; encouraging those not committed to reform to leave; simplifying; embracing mavericks; and not obsessing with structures – among other things.

Others suggest that, as well as just taking leads from the private sector, the public sector could look directly to the private sector. Chris Brown, EY’s UK head of business assurance, espouses the idea that savings that can be made by outsourcing (see box), while Desai says that the savings can only be made through a “strong in-house finance and commercial capability developed through academies in partnership with the private sector”.

But there is a danger in consistently looking towards the private sector, as there are fundamental differences between the two for finance directors. As CIPFA puts it: “Public services can’t pick and choose the markets in which they operate and switch on and off their products and services at will, particularly where statutory service can’t simply be shut down because there isn’t an adequate return investment.”

Even the CPS acknowledges that, unlike in the private sector, “the benefits of the 80:20 rule are not available: the most demanding (ie, expensive) 20% cannot be ignored (unless rationing were introduced)”.

There are other fundamental differences. Finance managers in the public sector “need to balance the requirements of our elected representatives with careful stewardship of their organisation’s resources”, says CIPFA – a particularly arduous task for civil servants.

And recent events have shown that public services are subject to even more constantly shifting demands, whether that be the current refugee crisis or the potential military engagement in Syria, CIPFA adds. These would require huge additional resources from elsewhere: “This means there is often a skewed focus on short-term financing rather than concentrating on the long-term picture.”

Such challenges mean that the 40% potential savings will be even harder than at first glance for Kelly and his colleagues. ICAEW chief executive Michael Izza’s prediction that the new government CFO will need to be “superhuman” may therefore ring true. By the time of the next election, we will know whether Kelly is more Superman or Hindsight Lad. 

Expert view: what is core and what is key?

Government departments need to have a think about what is core and what is key, and what can be done a little bit differently by potentially using the market. The 2010 spending review was all about looking at existing contracts and existing things they have outsourced, and thinking, ‘How can we get it done better for less?’ In this current spending review, they have to look at what else they can outsource to make these savings because it will typically save the government between 20% and 25%. There are examples of this happening already.

For example, the Metropolitan Police could be outsourcing its forensic service, which is a crucial piece of infrastructure to the criminal justice system. This would not historically have been something considered for outsourcing. The key thing is to get the environment right. We need an informed buyer and a motivated supplier. There are different ways of achieving this, but without that right environment, it will be difficult.

Government departments have learnt a lot over the years in terms of their first generation of outsourcing moving to their second generation of outsourcing. But there is a role for third parties to help regulate, help provide some kind of assurance regarding that informed buyer and motivated supplier relationship.

Chris Brown is EY’s UK head of business assurance and Wayne Gibson is EY’s UK head of operational assurance

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