Posted by David Gentry
Much has been written about how best to consider program performance, or the results of expenditure programs, when allocating resources in the public sector. Many writers are committed advocates of this seemingly common sense approach to budgeting, while others are deeply skeptical after looking at implementation issues. One way to contribute to this debate is to look at the experience in the private sector with a close conceptual cousin, Management by Objectives.
Management by Objectives (MBO) was first promoted in the 1950’s. Peter Drucker is credited with coining the term and promoting the practice in his 1954 book entitled The Practice of Management. The idea was further refined by George Odiorne in his influential 1965 book entitled Management by Objectives: A System of Managerial Leadership, and in a large number of publications by various authors over the years exploring the application of MBO.
MBO has two broad aims: to clarify the direction an organization should take and to measure success in taking that direction. Beginning with Drucker, objectives were applied both to individual job performance and to the performance of the organization as a whole. The connection between job performance and organization performance is explicitly made at senior management levels, where a manager’s compensation is often determined by meeting organizational goals.
The greatest challenge to successful implementation of MBO is the proper formulation objectives. There are several important considerations. First, objectives for individual employees must be aligned with objectives of other employees, managers and the organization. If objectives do not complement each other, the organization will go off course, and accountability will be misdirected. Second, the number of objectives imposed should not be excessive. There is a cost in terms of data collection and monitoring. Too many objectives make it difficult to see the overall strategy of the organization. Third, objectives must be set at levels that are neither too easy nor too difficult to achieve. The reach of objectives must be balanced between motivating individuals to attain the objective and the risk of failure.
The literature on MBO is silent on whether or not additional resources should be provided to a successful organization. Individuals should be rewarded, but organizations? In MBO, allocation of resources is based on a forward looking business strategy and operational plans to execute that strategy. Implicit is in the approach is that enough resources are provided to achieve strategy and operational goals. There may be diminishing marginal returns to providing additional resources to successful organizational entities, and there may be other ventures or organizational units that have higher potential returns. Similarly, more resources might be allocated to organizational units that have not performed well in the past but have the potential to improve.
The principal lesson of MBO in the private sector is that appropriate application of benchmarking and performance measures can improve organizational performance. In addition, past performance is instructive when estimating the likelihood, and resources required, to successfully execute business plans and strategy. However, there is often not a strong correlation between past performance and future budgets.
The efforts by the public and private sectors to focus on results have many similarities. The literature on, and experience in applying, Management by Objectives in the private sector is pertinent for those contemplating a serious effort to use performance measures in the public sector budget process. But a few notes of caution:
First, a performance evaluation system is not the same as a resource allocation system. Performance indicators measure the past, while investment decisions are future oriented. Second, public sector budget offices tend not to focus on personnel or management issues, even though these significantly influence the effectiveness and efficiency of public programs.
Third, performance measurement, particularly relating to outcomes, is arguably more difficult in the public sector than in the private sector for which outcomes are often measured in financial terms: profits, revenues, costs and market share. Accounting standards in the private sector have developed to a great level of sophistication to assess these measures
Taking MBO lessons learned and applying them to the public sector, the correlation between past performance and allocation of resources is likely to be weaker in the public sector because the public sector should go through logically similar analysis as in the private sector when allocating funds, but the public sector faces greater political forces that may influence budget allocations. Elections occur regularly. Policy priorities change, often independently of past performance. In addition, the MBO experience suggests that overall efficiency and effectiveness of government may derive as much from management improvements as from resource allocation decisions. Finally, any government that uses performance indicators in its budget system must carefully avoid any undue expectations by line ministries that good performance will automatically lead to bigger budgets.
The following papers on performance budgeting raise issues for the public sector that are addressed in the private sector MBO books mentioned above: IMF Technical Notes and Manuals, A Basic Model of Performance Based Budgeting, by Marc Robinson and Duncan Last and Performance Information for Managing and Budgeting: Challenges, Lessons and Opportunities, written by Teresa Curristine and Sang-In Kim following the OECD Working Party of Senior Budget Officers, 2nd Annual Meeting of OECD SBO Network on Performance and Results held 21-22 April 2005.
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