Understanding and Creating Public Value: Business is the engine, government the flywheel (and also the regulator)

Abstract

In this essay, we define the meaning and content of public value, show how government and business create public value, and briefly explain why their governance arrangements work the way they do. We deal first with business and then government. We conclude that government manages risks and that governmental value creation is distinctively concerned with stability. Hence, to make government work better, risk management ought to be central to the practice of public finance, public policy, and public administration. Understanding the importance of stability is potentially of even greater importance to those who research and teach public policy and administration. Indeed, we propose that the elaboration of a general risk assessment model explaining, among other things, government’s systemic inclination to stability, would take our field a long towards integration with mainstream positive social science and, therefore, holds out the prospect of considerable interdisciplinary consilience, although at this time we can do no more than suggest the contours of such a model.

Key words:

• Process
• mechanism
• government spending and taxing
• sustainability
• performance
• risk
• systemic risk
• public management

ACKNOWLEDGEMENTS

Earlier versions of this article were presented at the Workshop on Creating Public Value, University of Minnesota (2012), the 2013 Conference of the European Academy of Management, and the 2013 Conference of the Society for the Advancement of Socio-Economics. We acknowledge the advice and comments of our colleagues John Bryson, Sandy Borins, Steve Maser, Ken Smith, Aidan Vining, and Robert Walker and three very helpful and well-informed referees.

Notes

1 This paragraph reflects the basic presumption of Moore’s Creating Public Value (1995): public administrators engage in deliberative argumentation, whereby they choose a line of action because of its advantages, based on their knowledge, for the sake of creating public value. Moore’s approach to administrative argumentation (see Hood and Jackson 1991) is more casuistic and less deductive than ours, but is otherwise isomorphic.

2 The instrumental ethic outlined here is basically utilitarian. In assessing whether a proposed state is preferable to an existing one, it is necessary to consider the consequences for those affected. For people with large, well-diversified asset portfolios, Kaldor–Hicks efficiency (the winners could compensate the losers and still be better off) is an eminently satisfactory assessment criterion. Where people with small, ill-diversified asset portfolios are concerned, at least according to Bergson–Samuelson social-preference theory, winners must actually compensate losers; otherwise value creation is iffy.

3 In practice, the pursuit of profit all too often reflects an impoverished notion of the meaning of value creation. Tax avoidance, investments in lobbying, and various other rent-seeking behaviours produce benefits to shareholders (see Mathur et al. 2013) but are usually value reducing overall, i.e. they produce negative net benefits.

4 This norm does not apply to all businesses; banks, for example, create value by holding financial inventories, using equity, risk pooling, and hedges to manage inventory risk. It is not unreasonable to suggest that many of them got into trouble precisely because they lost sight of this purpose and instead got caught up in maximizing yields.

5 In practice, the covariant factors that generate systematic risk and their loadings are unstable over time. Consequently, the portfolios that investors must hold to diversify their holdings fully are huge, variable, and intractable. There are no perfect hedges. As we shall see this is a problem only government can mitigate.

6 We do not mean to imply that greater stability implies less growth. The evidence does not support that conclusion, quite the reverse, in fact (see Ramey and Ramey 1995). Sambit Bhattacharyya (2011), for example, reports that market-creating and market-stabilizing institutions promote growth. Market-regulating institutions produce diminishing marginal returns, beyond some point they reduce growth rates. Market-legitimizing institutions seem not to matter either way. As Sandy Borins reminds us: ‘Stability is not just an end in itself, but it underlies the ability and inclination of a nation’s entrepreneurs to take risks. Certainly we want them to do that to produce a more productive economy’ (personal correspondence).

7 Michael Barzelay (2001) formulated this statement of the public management agenda.

8 In point of fact, many of the scholars (e.g. Bryson 2004; Stoker 2006) who justify their recommendations in public-value terms propose practices that would be perfectly at home in the syllabi of the most parochial of business schools. That is hardly surprising, if ‘publicness’ is defined in terms of openness to and engagement with multiple constituencies, i.e. managing upward and outward, then Bozeman (1987) is surely correct: all organizations are public – to a greater or lesser degree (see also Perry and Rainey 1988).

9 Moss (2004, 1) defines risk management as ‘any... activity designed either to reduce or reallocate risk’.

10 While the logic may seem tortured to some, this is true even of transfer payments/redistribution (see Hochman and Rodgers 1969).

11 Insurance contracts are contingent claims contracts, formal agreements between a buyer and a seller whereby one of the parties (an insured) purchases an option from another party (an insurer), which can be redeemed for money if certain states of nature occur. The option is commonly referred to as a policy, its cost the premium and the states of nature are the events that are covered by it – death, illness, disaster, or old age.

12 Robert Shiller (1998) argues that modern financial engineering could overcome the size problem. While we find many of his arguments intellectually compelling, we are not persuaded overall. He implicitly asks us to distinguish idiosyncratic risks from systemic ones and we do not think that possible ex ante.

13 His point is that historical increases in affluence have resulted in corresponding reductions in mortality from accident and disease and that contemporary data on life expectancy and economic level point in the same direction: the lower the income class, the higher is the age-specific death rate. This is unambiguously an argument for social insurance, but it is also an argument against unbounded investments in measures intended to promote health and safety. Following Wildavsky (see also Viscusi 1994), Keeney (1997, 5) argues that these ‘costs are paid by individuals, which leaves them with less... income to make their lives safer and healthier’. Using data from the National Longitudinal Mortality Study, he estimates that each $5 million of investment induces a fatality, where investment costs are borne equally by the public, and approximately $11.5 million, where they are proportional to income. He concludes with the observation that these ‘cost-induced fatalities disproportionally burden the poor and minorities, particularly blacks’. While we are extremely sceptical of Keeney’s numbers, we find his logic compelling overall (see also Bhattacharyya 2011).

14 Conceptually, it makes sense to think of public spending on transfer programmes as negative taxes. Doing so would tend to promote coherence and consistency, not only from a macroeconomic point of view, but also in terms of their effects upon private saving, consumption, investment, and fairness overall (Buiter 1990; Mirrlees et al. 2012). The logic of the argument made here also implies that a government facing volatile economic conditions from aggregate production risk should probably rely on state-dependent tax bases. This observation reminds us that sometimes risk management is indistinguishable from fairness or equality, as in the case of intergenerational equity, but not others.

15 The importance of reliability varies inversely with redundancy. In the United States, home values depend on access to standardized, age-graded schools (Fischel 2009). Consequently, it is often seen as calamitous when schools shut down in rural areas, small towns, or suburbs. That is rarely the case in urban areas. Not surprisingly, both charter schools and portable vouchers are almost entirely urban phenomena.

16 Andrew Lo and his colleagues consider the implications of our position for epistemological/curriculum consilience across the social sciences and point to an example from public administration as a starting point, which makes perfect sense to us, given the special importance we claim for risk management to an understanding of government purpose. Elsewhere they (Lo and Mueller 2010) argue that the continuum of randomness should be treated as a set of discrete categories rather than as continuous and partitioned into five levels of uncertainty ranging from complete certainty to unparametrizable randomness. As thoroughgoing Bayesians, this approach makes us somewhat uneasy, but as a practical matter the suggestion looks to be both useful and robust.

17 This appendix is taken from Dothan and Thompson (2009b).

18 Arrow–Pratt risk aversion formalizes the everyday notion of prudence, given a concave von Neumann–Morgenstern utility function. The specific measure we use is called constant relative risk aversion because, in this case, it expresses the weight given to shortfalls (spending below some target level) relative to windfalls (spending above the target) as a constant ratio (based on the utility function’s second derivative). As such, it measures willingness to sacrifice current and future spending (by holding fund balances) to minimize spending variability around a target.

19 The rate of time preference formalizes the everyday notion of inter-temporal myopia. It measures people’s willingness to reduce future spending to increase current spending.

20 We assume that, so long as a jurisdiction avoids Ponzi finance, it can lend or borrow at the same rate.