Sunday, 16 August 2015

Government needs to develop better ways to make spending decisions

Government's’ failure to understand return on investment is catastrophic when budgets are being cut

The recent announcement of a new rounds of cuts to public health budgets (see the Kings Fund analysis here) has highlighted something rotten in the way government makes spending decisions. It smacks to me of something I’ve suspected for a long time: governments don’t have a sensible, logical or reasonable way to make good decisions about where and how their money is allocated.

The issue isn't as simple as “evil tory cuts” (though that is how many headlines will portray it) because Labour governments have also shown the same underlying failure to understand the difference between good and bad ways to spend their (or, as some would say: your) money.

The difference between Labour and Conservative ideas is often portrayed to be between those who want to spend more and those who want to spend less. Though both flavours of politician in the UK have run the country at times of both austerity and plenty and both have presided over regimens where both more spending and less spending have been appropriate. Both, however, have failed to show much insight into how to make the decisions about where the money ought to go.

There are several parts that contribute to this failure. One is that most government decisions are made top-down; they worry about the totals but not the details. Another is that many decisions are essentially political: that is they are determined by what looks good rather than what actually works. Inertia plays a role: once started many government activities are hard to stop and radical shifts in the allocation of money are hard to make. Fragmentation of decision making plays another role: the impact of decisions in one department on the costs in another are rarely considered carefully. Overall the impact of spending is rarely a serious part of decisions about the amount of spending (let’s call this a failure to understand Return on Investment (ROI) even though I’m broadening the terminology beyond its normal use in business).

In simple language there is certain tendency in governments spending more to believe that the only thing that matters is that more is spent. And those governments pursuing cuts tend to focus on the headline departmental budgets with little consideration for the long term effect on either outcomes or even the impact on total government spending in future years.

Businesses don’t do decision making like this. Or, to be more precise, those businesses who do make bad decisions persistently get driven to bankruptcy by the competitors who make better decisions. Governments lack this corrective mechanism and can persist with utterly rotten decisions on a scale impossible in even the largest private enterprise. In fact, while private sector firms are ultimately disciplined by competition and have to correct bad decisions or fail, governments have a built in tendency to never admit their failings--that looks bad in headlines--and therefore persist with bad ideas for much longer and on a larger scale.

The point I want to make is that good decision making in many businesses has characteristics that are frequently absent in government. In particular, successful businesses are good at considering the effect on the whole business of each spending decision. And, they tend to be smart at recognising when more spending in one area will lead to lower cost or greater success in another.

The core problem is that not all spending is equal; not all projects deliver the same results; not all budgets have an equal impact on their desire outcomes. Effective decision makers know this and direct their money towards the places where the biggest bangs per buck are achieved (or the return on investment is highest). This principle applies whether the money available to spend is plenteous or tightly constrained.

Another, more subtle point, is that the relationship between what you get and how much you spend is far from linear. Sometimes there is a minimal amount that must be spent to achieve anything; sometimes spending twice as much gets you little more than spending the right amount; sometimes a small spend in one area releases the possibility of a large benefit somewhere else.

Take the world of supermarkets. They succeed when the put the right goods on their shelves, at the right time, at the right prices to please their customers and do all this without spending an excessive amount on the logistics of the process. Supermarkets do this well not (just?) by screwing their suppliers on price but by having excellent logistics processes (which, in practice, means a lot of spending on tightly integrated IT systems to coordinate the whole supply chain from production, through delivery to shelf-stocking.) They are well aware that to succeed with customers means spending a great deal of money on things that don’t obviously have anything to do with customers (like IT and logistics).

In contrast, governments are often oblivious to the need to spend here to achieve a benefit there. They tend to impose blanket cuts across all departments when they need to cut back rather than asking whether increased investment in some areas could yield savings somewhere else. Hence cuts in public health spending when the NHS is faced with growing amounts of illness. Or cuts to the ONS when the government is already seriously lacking in good quality information about what is happening in the country (in fact, how does government work out whether any policy is working when its information about outcomes is poor to start with and the budget to collect better information is being cut further?)

The NHS is a microcosm of government kakistocracy here. To know whether the treatments offered by hospitals and GPs are any good we need vast quantities of high quality information about activity and outcomes. We get very little of either as NHS spending on data collection and analysis is a shockingly low outlier in the world of large organisations (headlines are made by declaring that a larger share of the money will go to “frontline care” when we are not prepared to spend the basic minimum to ensure that we know whether that frontline care is doing good or causing harm). Worse, the really big opportunities to improve the NHS are not in major top-down changes to the organisation or public behaviour but in the steady accumulation of small good ideas about how to do things better at the front line. But the only way to achieve cumulative improvement is to monitor activity and outcomes carefully (which means spending on data collection and IT) and to use this information to drive behaviour towards the things that work best. If we really wanted to save money in the NHS (and/or improve the outcomes) we would invest more in data and analysis with the benefit that medical practice would improve over time both saving money and leading to better results. Neither the naive belief that just spending more will make things better nor the opposite belief that cuts should come from somewhere other than the front line actually help much at all (we’ve tried both in the last decade).

Only a careful analysis of which spending will yield system-wide benefits will give a good return on investment in the NHS. So cutting public health budgets is easy to do but may cost more for the NHS as a whole in the future (probably: there may well be many public health projects that have little effect on outcomes or NHS costs but it is fairly clear that the recently announced cuts were not based on any such analysis). adding more staff to the NHS improves capacity but lowers productivity making it a worse investment than spending more to automate the tedious data collection that is often paper-based and wastes vast amounts of medical time.

The general point for government is that thinking about ROI is essential both when budgets are tight and when they are generous. Spending money on the wrong things yields far less benefit that it should; cutting the wrong projects yields far lower savings for government as a whole than it should. Discriminating far more carefully when spending decisions are being made (both when cutting and expanding the budget) could give major gains in how well public services work. Yet there is little evidence that this thinking is part of the way decisions are made on public spending.