A rethink of the way that governments operate, combined with tough cuts to public budgets, is critical if Western industrialized economies are to reduce the major public sector deficits they have incurred in dealing with the recession, a new study from KPMG International and Oxford Economics has found.
In the report, “Meeting the Deficit Challenge – Strategies for Fiscal Sustainability,” KPMG and Oxford Economics, drew together international data from previous periods of fiscal adjustment, plus economic research and insights from KPMG partners advising the government sector, and contributions from senior academic and public sector leaders from the U.S., U.K., Germany, Canada and Spain.
The study concluded that conventional fiscal measures are unlikely to be enough to sustainably manage current levels of deficit. Governments also need to adopt new ways of working such as developing new revenue streams and moving toward infrastructure privatization.
“Given the scale of adjustment needed, the level of deficit reduction and fiscal reform in the public sector suggests an agenda for a re-engineering of government,” said John Herhalt, Global Head of KPMG’s Government Sector. “The global financial crisis and recession has wreaked havoc on government deficits around the globe.”
“Government stimulus efforts combined with weakened growth are contributing to the widening of deficits,” Mr. Herhalt continued. “But deficit recovery strategies need to be constructed so as not to undermine growth. Simply ending stimulus programs and returning to normal economic growth will not address the magnitude of the issue.”
According to the study, in 2009, the average budget deficit in the G7 countries reached 10 percent of GDP, five times higher than in 2007. Equally important, on average across the G7 countries, total government debt outstanding exceeded 100 percent of GDP in 2009. Increasing pressures on government budgets from age-related pensions and healthcare costs will present a growing challenge which will only compound the problem.
The KPMG/Oxford Economics study found that maintaining status quo, with current government fiscal policies left unchanged, G7 deficits could reach as much as 200 percent of GDP over the next 10 years and over 300 percent in Japan.
In the past, countries have recovered from similar situations. Looking back, the study showed that there are over 20 cases of advanced economies, such as Ireland, Sweden, Finland, Denmark, Canada and the U.K., improving their budget balances by 5 to 10 percent of GDP in less than 10 years. This is roughly in line with what the IMF estimates is needed to restore fiscal stability today.
Those fiscal recoveries that were successful in the past were implemented while maintaining growth, were based on decisive, up-front spending cuts rather than increased taxes, and had social and political consensus.
The Way Forward to Sustainability- Re-engineering Government
Mr. Herhalt said that conventional approaches such as halting capital spending or instituting wage and staff cuts could offer short-term relief but would not be sustainable over the long haul.
“By contrast, the re-engineering agenda focuses on transforming the delivery of public services in a way that can reduce the future burden on the government budget and yield significant efficiency gains,” he said.
Several areas were outlined as critical to developing a workable re-engineering agenda for government.
“Developing a culture of cost control is critical,” said Paul Kirby, a KPMG Partner of the U.K. member firm. “The problem of rising long-term costs in key areas of spending reflects, in part, poor productivity in the public sector. We’re entering the age of the unit cost, whereby we need to analyze to the lowest level how much it costs the public sector to provide services.” he said, explaining that employing unit cost analyses across public sector areas could be very effective.
“The role of government needs to re-assessed and re-focused with the emphasis on making it accountable, so that we have governing bodies that are performance-driven and measured, and funded on results,” Mr. Kirby said. Private sector involvement in the provision of services could include such activities as registration and licensing, he explained.
Reducing deficit balances also requires looking for new revenue streams from, for example, environmental taxes or natural resource taxes such as those being considered in some resource-rich countries.
Empowerment at the operational level could prove very effective by giving middle managers, also referred to as ‘service providers’ more decision-making power and a stake in delivering successful outcomes. Such a model could encourage a culture of continuous improvement and provide incentives to watch spending and the bottom line.
Infrastructure privatization poses significant opportunities, according to Mr. Herhalt. He points to the inclusion of private investment in the transport sector of several European countries – something which has become commonplace after many years. “Involving the private sector more in infrastructure also meets a growing demand for access to the stable revenue streams infrastructure assets can generate.”
But contributors to the report are under no illusions that the road to re-engineering government will be an easy feat. “Radical transformational change in the public sector faces practical barriers,” said Alan Downey, a partner in KPMG’s U.K. member firm. “Many fiscal adjustments are managerially easy, but politically hard such as curbing welfare spending. And yet, improving public service productivity is by contrast politically easy but managerially hard.”
“Governments may initially have to ‘ride two horses at once’,” Mr. Downey said. “That could mean employing conventional fiscal adjustments while also laying the foundations for transformative government and enabling a separate process with independent, experienced leadership to drive innovative change.”
“Meeting the Deficit Challenge- Strategies for Fiscal Sustainability” is the third in a series of studies from KPMG on the future of the public sector. The first report, “The Wolf is at the Door – The Global Economic Crisis and the Public Sector” was published in 2009 and featured interviews from public sector leaders in six countries – Australia, Canada, Germany, Netherlands, U.K. and the U.S. - about their views on the impact of the economic downturn in the public sector.
The second report, “Tough Choices Ahead-The Future of the Public Sector,” published in early 2010, featured interviews with public sector leaders in the same six countries and coupled with research and the insights of KPMG partners and directors, which provided further analysis on the research with a focus on how to build fundamental change in the public sector.
The full report is available here.
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KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 146 countries and have 140,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such.
Oxford Economics was founded in 1981 as a commercial venture with Oxford University to provide economic advice, forecasts and analytical tools to international organizations. Since then, Oxford Economics has become one of the world’s foremost independent international forecasting consultancies, producing projections, analysis and data on 190 countries, 85 industrial sectors and over 2500 sub-regions and cities.