New government comes with new, old ways of thinking about problems

By Sense Partners 



In this issue:

Government speaks language of value for money 

Improving the quality of spending 

The new Coalition Government’s priorities include improving the quality of government spending and reducing core Crown spending as a share of the total economy. 

Against the backdrop of a deteriorating economic outlook the May budget was super tight. Government is reprioritising spending to initiatives that are proven or expected to deliver value for money. Luxon makes this clear:

“Governments do have a responsibility to control their spending. But they also need to be laser-focused on whether that spending is delivering value for money.” ¹

Back to the future?
Value for money is nothing new. Value for money underpinned the Key government. To us, the core elements and principles are well-known:
  • Strategic fit – do the activities promote stated priorities or legislated objectives, and address a clear market or regulatory failure?
  • Cost – how can government be confident that the inputs used (labour, capital) are employed or procured at least cost?
  • Efficiency – is government getting the maximum sustainable outputs from the inputs, or is there an excess of idle capacity or opportunity for a better mix of outputs? 
  • Effectiveness – are the outputs having the desired results; what does the available research evidence say on likely effectiveness and cost-effectiveness?
  • Ongoing value – what processes are in place to learn about the impact of activities, or to do things better as information, technology and consumer preferences change?

These principles should guide how to think about your issues and how to engage with the Government. Start by being clear on the why, the intended results, what evidence exists on effectiveness and efficiency, and gaps in knowledge you need to address. 
We demonstrate the approach with a selection of issues for commercial construction we show in this table (Figure 1) with supporting evidence that follows. The findings are not comprehensive. Rather, they are designed to show how ministries, advisors, Ministers, Treasury – the Government – approach your issues. Our findings also highlight where information gaps and strengthening the logic chain can help. Our takeaways: 

  • Government is seeking practical solutions: expect desire for engagement to be high
  • Strategic fit is excellent across many issues: but without further evidence, cost will define where reform is possible
  • Industry can influence the agenda: advocate in value-for-money terms

 ¹ See Christopher Luxon’s 15 May 2023 Pre-budget speech to the Auckland Chamber 

Stop work orders 

Public sector build costs appear of out control to this government 

 Several high-profile projects have experienced huge cost over runs².  This is nothing new³.  But the scale and breadth of overruns across many sectors, is shocking, including to the new government.

To understand drivers of cost increases, government has paused many projects. 

Across the economy construction costs have outstripped other sectors (see Figure 2), reflecting not just post-covid inflation, but also public procurement practices not grounded in value-for-money. Costs in the sector are 27 percent higher than immediately before COVID.

Figure 2: Cost rises in construction have outstripped the rest of the economy
Producers Price Index - construction (Dec 2010 = 1000)


Source: Statistics New Zealand

Some projects, like the Interislander ferry upgrades and school rebuilds, are halted for purely financial reasons. Other projects, like blowouts on public transport projects, have competing priorities. 

Our assessment 
Strategic fit
Stop work orders bring a sharp shock to the system. A harsh approach may be costly, but it may be the quickest route to restoring fiscal discipline within public sector procurement. It is a classic principal-agent problem – the government cannot directly manage procurement. It relies on public sector procurers and project managers to work towards value-for-money.

Cost
This approach may impose a high upfront cost to both the public sector and the construction sector. Halting in-progress work may incur expensive contract-break fees and expensive remediation work if/when work continues. The disruption in the midst of a recession creates uncertainty within the sector, deterring investment in capabilities we need. 

Efficiency
A sharp shock may impose discipline quickly, but it is also likely to create costly disruption. In contrast, a more gradual approach to reintroducing value-for-money would bake-in existing cost blowouts and may lose momentum and get bogged down. 
Incrementalism may also compromise the strength of the signal. Public sector procurement may doubt government commitment to ensuring value-for-money, further lengthening the time it takes to get costs under control.

Effectiveness
Work pauses alone will not deliver results. Sustained leadership is needed to clearly signal to the public sector that value-for-money must be a priority, now and into the future. 
Focussing on lowest cost will not deliver value-for-money. The focus must be on whole-of-life costs, including delivering lower operating and maintenance costs higher upfront build cost.

Ongoing value
Combined with sustained leadership setting clear expectations of value-for-money, this approach has the potential to set public procurement on the right track. Ministers must be clear and consistent in their expectations of value-for-money as long as they are in office. 

 ² See for example, “How did the cost of moving two schools blow out to more than $400m?”, “Wellington’s $1.2m bus stops costing more than a home”   
 ³ Bent Flyvbjerg and others document suggest “Underestimating costs in public works projects: error or lie”, Journal of the American Planning Association, 68(3), pages 279—295.
 

Reducing consenting red tape

Government motivated to tackle unnecessary regulation 

The Minister for Building and Construction couldn’t be clearer last month: “we need to reform the building consent system and reduce red tape.” ⁴ Strategic alignment on this issue is strong. And there is a body of evidence to hit go.⁵

And for good reason. Delays, inconsistency in processing consents across building consent authorities, risk aversion and poor incentives in the system means New Zealand cannot easily innovate and adopt practices from elsewhere. Sector participants report technology uptake is not driving change to the same extent as other sectors (see Figure 3). 

Figure 3: Surveys show tech change has less impact on construction than other sectors

BOS, Question: “Over the last year, to what degree did this business’s technology change?”



Source: Business Operations Survey, Statistics New Zealand

Our assessment 

Strategic fit

Strategic fit is excellent. New Ministry of regulation shows the intent of the new Government across sectors. Minister has clearly signalled a desire to do more and at pace. 

Cost 
There are start-up costs and institutional change will take time, but these are not large investment costs relative to the size of the pie. 

Efficiency
Expect reduction of red tape to improve how inputs are organised to produce housing. Firms that can invest in understanding then adapting to new processes could gain a competitive edge. 

Effectiveness
Reducing red tape risks and streamlining the consent process without quality controls could risk long-term outcomes. But making the most of digital technologies can improve the sector without risking outcomes.

Ongoing value
Industry should engage and seek to lead change. Industry should be clear on the problem, and preferred option among alternatives. 

What might the return on investment look like for preferred options that might include:
  • A single national consenting body rather than the multitude of agencies relative to international peers, like Australia.
  • A scheme that incentivises good behaviour with fewer and more timely checks.
  • Making the most of digital technologies and remote inspections that hold promise but remain largely unrealised.

 ⁴ Honourable Chris Penk, “Making it easier to build”, speech to NZ Institute of Building Surveyors, March 23, 2024
 ⁵ See for example the MBIE-led 2023 consultation process

Building the dips 

Boom/bust cycles undermine the sector

The boom/bust cycle makes it hard to sustain a low-margin construction business at scale. This prevents vertical integration, instead promoting a decentralised model that enables businesses to rapidly shed labour costs. The argument is these cycles stunt productivity growth and force skilled workers out of the country (see Figure 4) and government should step in either by providing a subsidy for building new homes or building social housing.

Figure 4: Housing boom-bust cycle means firms shed labour reducing productivity 

Panel A: Labour fell rapidly after the GFC

Source: Statistics New Zealand

Panel B: Productivity then low for years
Index (1996 = 100) 
  
Source: Statistics New Zealand

Our assessment 
Strategic fit

Well targeted counter-cyclical investment in the construction sector could help to smooth out the cycle. But there are many issues that suggest a poor strategic fit for this government:

  • Timing: government is slow to mobilise and unlikely to time investment for the trough
  • Social housing: this government likely to seek private rather than public solutions to social housing
  • Sector reform: government will point to wider sector reforms (red tape and RM reform) as providing the boost the sector might need. 
Cost 

Under-writing private sector developments in-progress or in advanced stages could speed up the response by bypassing the planning and consent stages. This rapid path to administering stimulus could come at a high cost, particularly as Government may need to take on a large risk. 

Efficiency

Targeting in-progress developments improves the chances of investing where there is already a good business case. This has advantages over non-market driven investment in directing resources to their highest and best use. A better chance of good returns when the market stabilises is a good pairing with rapid deployment of stimulus. 

It is only a good idea to build through dips if:

  • the projects are a good idea (necessary but not sufficient condition = BCR>1)
  • the money/resources would not be better used for some other purpose (BCR > BCR of alternatives)

These are standard considerations: ergo there is nothing special about dips. It is bad idea to build through dips if it leads to higher risk of:

  • projects that are not a good idea (BCR<1)
  • crowding out of more worthy/beneficial projects (BCR<BCR of alternatives). 
This is a non-standard consideration. Many will argue building through dips for reasons of maintaining a workforce or capability increases the risk of bad spending – not least because government does not have skin in the game.

Effectiveness
Direct government investment, through social housing or infrastructure, isn’t agile enough to respond to downturns. Under-writing ongoing private developments could speed this up, but it still requires government and public sector agility in identifying projects and negotiating deals. This capability will take time, effort, and concerted leadership to build.

Ongoing value
Over time, a demonstrated ability to underwrite projects with sound business cases during downturns could build confidence in the sector, promoting investment.

There is a high risk that government entry increases risk taking under the expectation of an underwrite if things go wrong. A clear assessment framework is needed to distinguish between poor investments by developers and a wider downturn. 

Improving government procurement capability

Sector has long been plagued by poor government practices

Poor procurement capability within government has long been recognised as a key use for the construction sector and other sectors.⁶  Increasing complexity of design adds to problems. Lower price bids with higher default risks have won out over higher price bids, with procurers paying insufficient consideration to the risks associated with bids with razor sharp margins. 

Surveys suggest practices and capability is declining rather than improving (see Figure 5). 

Figure 5: NZ Government Procurement Survey shows declining performance
Percentage of businesses that rated competencies of their contract managers positively 


Source: Business Operations Survey, Statistics New Zealand

Strategic fit

Government wants to continue to invest in infrastructure but in a cost-effective manner. Increasing capability and competency of the public sector fits well with direction of Government. 

Cost

This approach may impose a high upfront cost to both the public sector and the construction sector. 

Efficiency
For all but the best local performers, project management and project controls lag best practice internationally.

Effectiveness
A shift away from focussing on short-term costs by off-loading risk and towards better alignment of risk and incentives would likely increase the effectiveness of government procurement.

Ongoing value
It is a classic principal-agent problem – the government cannot directly manage procurement. It relies on public sector procurers and project managers to work towards value-for-money. 

Expect a greater focus on government procurement practices to improve value for money with a whole-of-life framing.

Combined with sustained leadership setting clear expectations of value-for-money, this approach has the potential to set public procurement on the right track. Ministers must be clear and consistent in their expectations of value-for-money as long as they are in office. 

⁶ For example