Summary

This paper deals with the relation between the structure of the economy and the system of government and city management. It shows that the structure of different economic sectors requires different systems of management.

The economy is divided into three sectors: (i) necessarily monopoly sectors; (ii) sectors of oligopolistic (imperfect) competition); (ii) truly competitive sectors (perfect competition). Each sector requires a different management system.

(i) monopolistic sectors require the most direct possible state control – privatization of a monopoly will be extremely economically damaging as the private sector seeks to maximize the monopoly profits;

(ii) oligopolistic sectors require partnership/collaborative working between companies and city and government, including a competitive mixture of state and private suppliers.

(iii) competitive sectors (perfect competition) should be served by the private sector with the state primarily seeking to improve the perfection of the market ( e.g. ensuring greater information).

The examples taken are from London and deal with areas such as the transport. However the principles are general ones which may be of interest in China.

The paper was originally written In 2000. Some purely historical or specifically UK material has been removed. It was originally published as Management Philosophy of the Greater London Authority (GLA).

Introduction

From an economic point of view, the key effect of the Mayoral or government management system is the ability to tackle a series of interrelated problems from a single centre. As an economy functions as a single whole, with a decision in one area being impossible to take without consequences for others, policies cannot be successfully implemented in technically unrelated fashions, addressing interconnected issues separately. Successful policy implementation requires simultaneous execution of mutually reinforcing decisions in different spheres. The Mayoral government system permits this.

Policy Framework

The failure of the earlier method introduced in London from the mid-1980s, alongside a run-down of infrastructural resources, was shown most spectacularly in the elimination of the strategic government authority in London, but also in drastic reduction of the powers of the boroughs, the transfer of the greatest possible number of functions to quangos, the privatisation of the maximum possible number of functions and services etc. It is crucial to understand why this latter approach, paralleling the severe reduction of resources, inevitably led to the severe worsening of services and created a non-consumer driven culture.

The theory that underlay the steps embarked on from the mid-1980s, was that allocation of resources should not be determined by priorities set by the people but by unfettered operation of the market. In the case of privatisation an additional assertion was introduced that a link between ownership and management would increase the efficiency of allocation of resources. Its economic consequences, and destruction of services, in particular the possibility of these being consumer oriented, however, should be clearly understood.

In cases where competition, that is consumer choice, exists, profit-maximising performance is capable of delivering consumer-oriented behaviour—if the consumer is not satisfied their custom is transferred to other providers, and generation of profit is impossible. But the great majority of services that are government responsibility in London are not competitive but are formally, or in reality, monopolies. This is self-evident, and legal in the case of the Metropolitan Police, and Fire and Emergency Services, but also is de facto the case with the Underground and great majority of the bus services. Competition may exist in the case of certain inputs into the services, but delivery will remain monopolised.

In the case of monopolies, profit-maximising/ shareholder value enhancing behaviour must necessarily seek to utilise to the full the ability to secure monopoly profits/rents. There is no mechanism delivering consumer-oriented behavior. Subject neither to competition nor to accountability to the people monopolies necessarily created a culture whereby their objective became serving themselves. The reestablishment of accountability at the top is therefore the first indispensable precondition for the creation of consumer-oriented services in London. The challenge is to ensure that such a reorientation reaches all parts of service provision.

The guiding light of this policy is improvement of quality of service. The reasons for this are evident. Provision of services in London has fallen below the point of tolerance for the public, and to the point where it significantly impairs the economic/business efficiency.  Far from London, and its population, requiring further reduction in provision of services it requires an increase—in particular in their quality. The emphasis of improved services in the UK as a whole is particularly required in London. The improvement of quality of service, the redeployment of resources to improve that service, and the creation of a consumer-oriented culture to achieve this, must be the guiding provision of the budget and the review accompanying and following it.

Management Principles

This indicates the management principles on which the GLA is organized; it is necessary to integrate them with guiding economic ideas.

Other things being equal, private sector provision is inherently more financially expensive than public sector provision. This is necessarily the case as a dividend, or equivalent payment, must be paid to owners, i.e. costs must include not only investment and running expenses, but also a dividend equivalent. The latter is not necessary in the case of a public sector company.

Second, private sector borrowing is typically more expensive than public. Although this extra cost may in principle be offset by special mechanisms, in practice the cost of provision of capital to the private sector exceeds that to the public sector. The inherently more financially expensive character of private sector provision, which may be expressed as lower quality at the same cost, may, however, be more than offset by private sector advantages such as:

•Efficiencies produced by competition.

•Large (potentially international) scale of production.

•Securing more qualified management by higher pay scales.

•Different conditions of employment in the private and public sectors.

However for private or outside sector provision to be financially justified, these advantages must be quantitatively sufficient to offset its inherently higher costs.

In cases involving scale of production, this factor may itself be decisive in producing a better value private sector provision—London Underground producing its own rolling stock, for example, would be more expensive than for companies with larger (international) scales of production.

However, management skills are an (internationally) traded commodity, and as such have market rates. A public sector paying less than market rates, of which the largest element is the private sector, evidently cannot secure the best such talent. A more financially rational course may be to increase managerial pay to secure the best talent while retaining an entity within public sector provision—this will depend on the balance of the increased cost of securing the best management and the efficiencies it produces, compared to the extra costs that will be incurred in private sector dividend payments and increased borrowing costs.

Specific Managerial Steps

The philosophical stance outlined above translates into the specific features of the approach adopted by the GLA:

•The conceptions outlined would lead to a different overall macroeconomic approach to the current one if applied at the UK level. However, at a London level, in the competitive sector, they currently lead to no demands for intervention by the Mayor other than those used by all governments. As the bulk of private companies are in the competitive sector this evidently creates a stable basis for Mayor– business relations.

•Sectors where oligopoly or imperfect competition exist are a complex case, of which a specific example, the bus system, is analysed below.

•The dramatic difference in approach lies is the monopoly sector in which, as outlined above, the GLA itself is one of the main suppliers in London.

The Government’s method for attempting to deal with the well-known economic issues posed by natural monopoly provision, including in the public sector, has been to seek to introduce competition artificially. In a number of cases, this has meant treating physically inseparable productive systems as though they could be juridically divided into competitive entities. As the ownership and management system thereby created no longer corresponds to that of the physical system, it combines the worst features of both. Because juridically introduced ‘competition’ is artificial so, in practice, it is largely non-existent, while the juridical separations that were introduced fragment the management of the unitary asset and so reduce its efficiency. Railway infrastructure company Railtrack’s history, with artificial separation of infrastructure from operation, provides a good example of the consequences of such attempts. The Public–Private Partnership (PPP) system, which the Government is attempting to introduce in the London Underground, will produce similar results.

The managerial approach of the GLA takes the fundamentally opposite starting point. Juridical and institutional systems must correspond to reality, not vice versa. Systems such as the Underground and rail networks are inherently monopolistic in regard to their central functioning. Juridical attempts to introduce competition destroy management efficiency, while not actually eliminating monopoly rents—which may be expressed in the form of low quality of service (i.e. below-average quality delivered at average cost). In the GLA approach, however, the pressure for a consumer-oriented culture is exercised by the compulsion on the Mayor, who is accountable to consumers and politics and not the monopoly.

The Example of Transport Fares

These issues can be illustrated by looking at the problem of public transport fares. Transport for London (TfL) and London Underground Ltd (LUL) face classic conditions for the generation of monopoly rents—they are monopoly suppliers facing inelastic markets, in particular the need of consumers to travel to work. Other things being equal, under such conditions, huge increases in fares to capture these rents would develop. The only issue would be who would capture such rents. If the system were in the private sector, monopoly rents would be captured by the companies and their shareholders. As they are currently in the public sector, the rents may be captured by existing institutional structures. In this regard, it should be noted that rents might be captured by a deterioration in quality, or inefficiency (i.e. excessive payment for or squandering of resources), as well as excessive price. There is no pressure for efficiency in such a system, as there is neither competitive pressure nor accountability. Therefore, if such rents are captured by the bureaucracy of the system there may be a combination of very high fares, low profits or large losses, and great inefficiency. The well-known features of London Underground Limited in the past — a combination of all three—is therefore a logical product of the institutional system of incentives and disincentives under which it was placed.

Transfer of the main functions of LUL to the private sector, but with the ability of the Mayor to set fares will not solve this problem. As monopoly rents may be captured by delivery of lower than average quality, the case of the Mayor limiting fares for a private sector monopoly will be likely simply to lead to low quality of service provision. As the system, by its nature, cannot be subject to effective competition, no way forward for creating efficiency lies down this route.

The Mayor, evidently, has entirely different priorities from the monopoly service provider, which translate into pressures for efficiency. Fares higher than those necessary to sustain costs and investment in the system, which reflect inefficiency, are political bad news. The Mayor’s incentive is therefore to wring the inefficiencies out of the system—this being the means whereby consumer preference exercises itself. Efficiency within the system is provided, other things being equal, by the degree to which those parts of the structure that are dependent on the Mayor predominate over those rooted in the monopoly.

Management Implications

The management requirements flowing from such arrangements can be readily determined. The political system must   transmit consumer pressure. The management linkages must be as direct and tough as possible to transmit these pressures. A combination of the greatest accountability and management institutions most directly expressing the pressure from the Mayor would, other things being equal, be optimal—this being a fairly good description of a coherently functioning Mayoral system.

Conceptually, at the centre is a mayor subject to accountability , i.e. consumer preference. Each successive link is under less pressure from the Mayor and greater from the monopoly structure. This is expressed not merely in Mayoral reach but contractually—the Mayor is subject to replacement, the Mayor’s immediate advisers have contracts limited in time to the Mayoral term and may be removed at the Mayor’s will, the next layers in the structure have permanent contracts and so on down the system. The maximally efficient ‘transmission belts’ of pressure on the monopoly structure, and in contrast those that will minimize such pressure, include:

•The management structure should be as flat as possible with the minimum number possible of linkages between the Mayor and service delivery, as each additional one is likely to reduce consumer/political pressure and increase that of the monopoly structure.

•The management and financial/accounting structure must be maximally transparent to open up the system directly to political and Mayoral pressure.

•Managerial pay must not be set by a principle that public sector pay must be below that of the private sector, but simply by the balance of payments paid versus savings made – such savings including comparison to the extra cost that would necessarily be incurred in a number of sectors by bringing in private sector provision. The Mayor cannot escape the market rates for managerial skills, and must therefore pay these—reducing pay below market rates will simply create managerial inefficiencies that generate greater waste than the savings from low salaries.

•Given that managers are being introduced into a monopoly environment, they must be as subject as possible to easy removal by the Mayor, directly or via those the Mayor appoints.

•Where the management structure cannot be made extremely flat, for technical, operational, or other reasons, the Mayor will require investigative bodies, answerable as directly as possible to himself, that can short-circuit the hierarchy.

It may be argued that the managerial structure thereby imposed—highly paid managers, subject to relatively little security of tenure, flat management structures, and the possession by the chief executive (the Mayor) of investigative bodies capable of circumventing the normal management hierarchy—is much closer to that of a private company than of the traditional public sector. The answer is that these are simply characteristics of efficient structures, and the fact that the Mayoral system replicates those in the competitive private sector expresses the effects of his pressure as the instrument of consumer preference. The traditional characteristics of the public sector (deep hierarchies, difficulty of removing managers, lack of transparency, lack of possession of instruments capable of bypassing the hierarchy) are merely symptomatic of the logical functioning of monopoly bodies that are minimally, or not at all, subject to consumer preferences and pressures.

A more detailed application of these principles in one sphere, transport, will now be considered, together with shorter observations on its applicability in others.

Transport Management

Transport for London is the body in which the Mayor has the greatest direct powers of governance. The Mayor appoints the Board, with a right to chair it. The Board appoints TfL’s Commissioner for Transport (chief executive). The Commissioner controls the management structure subject to the rules of contractual obligation. As the Mayor appoints the Board, the Mayor can replace a chief executive at will and thereby exercise tight pressure over the management chain.

Seen in this light, the appointment of Robert Kiley, the former head of the New York Metropolitan Transit Authority, was not a single political ‘master-stroke’, as suggested in the press, but reflected the management approach of the GLA. Similar principles, in a less highly publicised case, had been utilized previously in the appointment of the Board of the London Development Agency (LDA), see below. The Mayor was subject to popular pressure on transport and sought the best managerial talent in the field. The salary required to secure this was the highest in the public sector—£500,000 a year with performance bonuses plus a benefits package, but the payments were small in comparison to potential benefits due to the crucial role of transport. Kiley in turn set about reorganizing the top management of TfL, utilizing first a specialist in management contracts and organization, and then making a series of appointments, starting with TfL’s finance director.

Management reorganization will clearly proceed down TfL’s structure. Transport provision spreads across a number of specific areas, of which three major systems were confronted — the Underground, bus provision, and taxis.

London Underground:

 The introduction of the Government’s proposed PPP for the Underground would transfer monopoly rents to private sector companies, while removing the only element, accountability, that could deliver efficiency, and simultaneously institutionalizing deterioration in efficiency by the juridical fragmentation of the management of an inherently integrated physical asset. That individual independent studies have found the Government’s proposed PPP to be certainly inefficient, and possibly unsafe, simply reflects the effects of the underlying economic error.

TfL’s proposed alternative uses private sector provision where this is clearly more efficient due to economies of scale, competition, or other factors (for example rolling stock, infrastructure construction) while maintaining unified management of the system. It thereby corresponds to the physical character of the asset, the pressure for efficiency of the  accountability of the Mayor, and utilizing the cheaper borrowing available to the public sector.

The Bus System:

The bus system in London has an oligopolistic character, rather than being a monopoly supply. Six companies provide three quarters of capacity. The pre-TfL bus regime, instead of starting from the actual structure of the industry had pursued the juridical fiction that a supply-side structure approximating to the conditions for perfect competition either existed or could be created, i.e. including a large number of potentially substitutable suppliers. This approach was pursued through attempting to reinforce competition by artificially maintaining in existence alternative sources of supply in the form of small companies that were in fact less efficient, and therefore incapable of competing due to industry economies of scale (scale of vehicle purchase, centralization of servicing, ownership of garages etc.) with the larger oligopolistic suppliers. On the supply-side, artificial maintenance of smaller suppliers therefore had the perverse economic effect of lowering the average efficiency of the total system.

The demand-side effects were equally negative. Although the bulk of bus services were supplied by six companies, so that resolution of issues in these areas would have overcome the key problems confronting the system, no specific concentration of effort was applied to these. Instead, the pre-TfL bus division had become a vast, relatively undifferentiated ‘procurement machine’, intent on administering the procedures for awarding bus contracts, rather than delivering service improvements. The new system introduced by TfL’s head of buses has adopted instead an ‘alliancing’ approach to the main suppliers.

Taxis:

At a superficial glance, the structure of both supply and demand in the taxi trade may be taken to approximate to a classically competitive market, with a large number of suppliers and customers. Indeed, the appropriate policy framework flows from this structure. But there are a number of specific features that are either inherent or result from the pre-existing system. In particular:

•The supply-side is radically bifurcated, with strong restrictions on entry into one segment (the black cab trade, via ‘the knowledge’) and unrestricted entry into another (minicabs). Only black cabs may ply for hire on the street.

•Black cab fares are legally set by the Mayor.

These features are connected. If the free market sets fares under conditions in which supply is restricted, fares will be artificially high. The present system, which prevents this, however, creates clear tensions and problems:

•The restricted supply to the black cab sector inherently puts upward pressure on prices.

•If the Mayor puts prices below the rate that would be established freely by this restricted supply, then certain less attractive or less profitable parts of the market will not be supplied and there will be unmet demand— empirical evidence indicates this in the severe shortages of taxis for night and evening fares and in the suburbs. If, however, fares are set at rates that are sufficient to balance supply and demand, then not only will there be resulting unpopularity of high fares but no adequate increase in supply will be forthcoming due to entry restrictions.

The current result of such a distorted structure is that various participants have ‘justified’ complaints resulting from the operation of one part of the system but that cannot be corrected without worsening the situation of other sectors.

It might be considered that a possible approach to such a market would be ‘big-bang’ deregulation—i.e. removing all restrictions to entry and therefore establishing a lower market clearing fare. But there are a number of compelling non-economic reasons why this is undesirable. Allowing the marginal dis-utility of assault, murder or death in an accident (potentially resulting from an entirely unregulated system) to be matched via the market to the marginal utility of lower fares is clearly not acceptable. The present system of not licensing minicabs has already created socially unacceptable consequences, and for this reason the public demand, expressed in the GLA Act, has been to establish, not remove, regulation of the taxi trade—with the Mayor legally required to introduce regulation to the minicab sector.

As regulation is required, a more promising approach is to accept the bifurcation of the market. Black cabs will supply its top end, the higher price central London market. In this case fares can be allow to rise to market clearing rates (for example by higher night fares). Minicab supply the lower price suburban market. Supply in the black cab market can then be increased without loss of income by existing drivers. These measures permit a more gradual approach towards a structure dominated by perfect competition within minimum bounds set by minimum standards of regulation.

Other Structures of the GLA

There is insufficient space here to examine in detail the other structures of the GLA although some brief observations are in order. The core GLA consists of the Mayor, the London Assembly, and the various structures directly servicing these. The core GLA is a relatively small structure compared to the necessarily large—scale service delivery bodies (LDA, TfL, Metropolitan Police Authority etc.), following the principle that there should be the minimum of linkages between the Mayor and delivery bodies.

The Metropolitan Police Authority (MPA)

The Metropolitan Police represent the most difficult issue facing the GLA from an economic/ budgetary, rather than operational, point of view. The police are inherently a monopoly, with no possibility of alternative ‘supply’. In London they have never been locally accountable since their creation, over a century and a half ago, and evidence shows the Home Office exercised no close financial supervision. Such a combination would be logically predicted to produce opaque and inefficient financial structures, and it is widely admitted that this is the case. The Metropolitan police are at the leading edge of techniques in criminology such as DNA, but not, in the view of many observers, from a financial or budgetary point of view.

Simultaneously, the GLA Act deprives the Mayor of control not only of specific operational police matters, which is logical, but of the appointment of either an effective majority of the MPA or the Commissioner. Within the Met, the Commissioner does not appoint his deputies. In short, the system introduces institutional fractures that are the opposite of the requirements for achieving efficiency.

Progress has commenced along two fronts in this issue, through the agreement of the Mayor, MPA and Metropolitan Police Service in setting up an efficiency review, employing external consultants. Given good will, this should produce results. However, for the reasons outlined at the beginning of the article, it is unlikely that the full efficiency improvements possible can be delivered without an eventual change in institutional arrangements. The improvements brought about by Mayor Giuliani in the New York City Police Department, for example, directly relied on the ability of the Mayor to appoint the Police Commissioner, and the answerability of all lower ranks to the Commissioner. Principles of economic efficiency will require a movement in the direction of the New York system, with the Mayor either appointing the Commissioner directly, or via appointment of a majority of the MPA, and the Commissioner appointing his deputies.

The London Development Agency (LDA)

The LDA is the area in which, after TfL, institutional arrangements most closely correspond to the requirements for economic efficiency. First, while the LDA has significant legal powers, it is far from being monopoly supplier—in quantitative terms it is a relatively small economic actor in London’s £130 billion+ economy. Its role is to manage certain key development projects and to develop leadership in economic strategy—in which capacity its real weight will depend on the quality of outputs. Institutionally, the Mayor has extensive powers, with the right to appoint the Board, which in turn appoints the chief executive, thereby transmitting a pressure through the entire managerial structure, and to issue ‘directives’ to the LDA. The main legal limitation is that the Board must contain a majority of members (eight), including the chair, who have experience of running a business, and three members from public bodies. It is almost inconceivable that any Mayor would be incapable of meeting such criteria while setting an overall policy framework.

The appointment of the LDA Board was the first public indication of the management philosophy of the GLA. It far exceeded the requirements of business representation in the GLA Act, by including executives from large companies (Arthur Andersen, Saatchi & Saatchi, Jones Lang Lasalle etc.), and was still 40% female and 20% black and Asian.

Conclusions

The management system adopted by the GLA clearly produces strong conflicts with groups seeking to secure or utilize monopoly rents—either private companies seeking an exclusive franchise, or public sector bureaucracies via the inefficiencies in monopoly providers. The elimination of monopoly rents is beneficial not only for the consumer but for business as a whole, in reducing its costs.

Results are important, not mechanisms. The issue may be likened to the engine-room of a cruise liner. It is neither necessary, nor desirable, that the passengers should visit it, and it is not an end in itself. The pleasurable part of the cruise for passengers  is provided by the quality of the decks, the recreation areas, the cuisine and the entertainment. However, the engine room is vital in order to get from one place to another and for the success of the trip it requires just as much attention as any other part of the ship.