1. INTRODUCTION

The government or public sector of most nations typically accounts for between one-quarter and one-half of all economic activity. Yet the criteria that we evaluate the effectiveness of such services is not automatic, as it is in private business enterprise due to the disciplining effect of the market, but must be imposed. Democratic mechanisms function to both reward and discipline political parties and thus to create incentives to improve public services. However, in the short run, the evaluation of the management and provision of public assets and services rely on criteria of efficiency.

There is a vast literature on the economics of government services, optimal policy, social and public choice theory and political economy that is based on a framework of instruments and targets, or mechanisms and goals, as evaluated in terms of efficiency. This is both in terms of the goal (e.g. Pareto efficiency for an allocative goal) and also the means by which it is achieved, such that some mechanisms may be more efficient than others in achieving the same goal (e.g. an income distribution target, or a target level of production of a service). It is thus a widely held axiom that public sector management of assets and provision of services is properly evaluated as effective when it is judged to be efficient. In consequence, improvements in the management of public assets and in the provision of public services are then implicitly defined as anything that renders these services more efficient (or less inefficient).

However, this evaluation criterion is only meaningfully defined with respect to assets and services that already exist. It excludes from the outset criteria that relate to the innovation of new services or even the elimination of services because the efficiency criterion is meaningless in such cases. This, in essence, is why innovation is difficult in the public sector. The goal of efficiency is inconsistent with the goal of innovation. Put differently, this is why one-half to three-quarters of the economy remains in the private sector where this inconsistency does not hold.

Now although considerations of economic efficiency do not of course entirely determine the nature and shape of all public policy and government actions--for these are also driven by political expediencies, citizen pressures and realpolitik--it remains a widely held axiom of both effective policy and good governance that to go strongly against considerations of economic efficiency makes for bad policy. This is easily witnessed in public demand for, and government accord with, the general sensibilities of transparency, accountability and efficiency in the conduct of government economic intervention in the drafting of regulation, the use of public money and the management of public assets. Yet I shall argue here against this seemingly sensible proposition by noting the implications of it going too far: indeed, I shall specifically argue the benefits of a reduction in efficiency.

I am of course not arguing that public policy and governance can be improved by a significant increase in inefficiency, in the sense of indiscriminate waste and corruption. Rather, I seek to discriminate between different sorts of waste (as the opposite of efficiency). I shall distinguish between 'bad waste' due to rent-seeking and 'good waste' as the cost of experimentation. I shall then argue that the much vaunted aspiration toward universal efficiency in the public sector has indeed successfully eliminated much 'bad waste', but at the price of also eliminating much 'good waste' as well. And in doing so, it has constricted innovation. I shall seek to explain the logic of how this situation has arisen, why it is a problem, and what might be done to remedy it.

2. GOVERNMENT IS A SERVICE

Our starting point is that government (and governance in general) is a service. It provides services of defence, law and order, transport and communications infrastructure, health services, education services, social services, regulatory services, and so on. Some of these services can of course be provided wholly or in part by the private sector, but there are often good reasons associated with information asymmetries, free-rider problems or difficulty of defining and enforcing property rights that underpin a 'market failure' rationale for public supply of such services. The point remains, however, that although government is outside the 'price mechanism' in these circumstances it is not outside 'the economy'. Rather, it is still fundamentally part of the economy as a provider of valuable services. That is why it is legitimate to talk about the efficiency of government services. Yet this is also why it is equally legitimate to talk about uncertainty, enterprise and innovation in the economics of government services.

At this point, however, debate usually fixes on the question of comparative efficiency: i.e. for any given service (say geriatric health care), and for given citizen or consumer preferences and incomes, what then is the most efficient way of achieving that goal? But in formulating the question in this way we have implicitly presumed to deal with a static conception of both government and the economy. We have implicitly presumed that: (a) there is one best way of achieving the goal efficiently; (b) that it is known or knowable by someone; and (c) that this best solution can then be rationally chosen and implemented. Any failure along this line leads to inefficiency, which is of course bad. Yet note that, in this view, there is no place for innovation. Innovation, along with uncertainty, entrepreneurship, imagination, experimentation, competitive enterprise and technological and structural change are excluded, by definition, because of the initial presumption that the one best solution is already known (or knowable) and that the problem effectively lies only in its implementation. The rational pursuit of efficiency denies the very existence of innovation.

Of course there is no shortage of recognition of the need for innovation in the provision of public services (Golden 1990; Osbourne 1998a, 1998b; Newman et al 2001; Bhatta 2003; Mulgan and Albury 2003; Walker 2003, 2006; Kanarck 2004; Hartley 2005; Albury 2005). Furthermore, economic commentators are often resolute about the need for efficiency in public services while simultaneously making perennial calls for the promotion of innovation in public services. Yet there is little recognition that these two goals are mutually inconsistent (Parsons 2006).

This is a curious situation, as the study of innovation in services is a well-developed component of industrial economic analysis (e.g. Gallouj and Weinstein 1997, Metcalfe and Miles 2000, OECD 2001, Tether 2003, Miles 2004) and a significant explanation for economic growth (e.g. Riddle 1986, Romer 1994). There is a broad understanding in the economics of innovation literature that the innovation process requires experimentation and a high tolerance over organizations and institutions for both risk-taking and failure (Dodgson et al 2005). Yet the pursuit of efficiency involves, effectively, the very opposite of this, namely risk aversion, intolerance for experimentation, and a preference for proven 'winners'. It is surprising, therefore, that this basic point has seemingly been so widely overlooked in the analysis of public sector innovation.

The incentives and outcomes in the 'production of public services' industry (i.e. government) in stable modern 'rule of law' democracies are now often efficient, transparent and accountable, yet the incentives and outcomes to innovation remain exceedingly poor (Albury 2005). One possible explanation is that government is a monopoly service provider and, like all monopolies, experiences little pressure to innovate (Schumpeter 1945). Yet this argument is flawed. Monopolies do innovate, and often powerfully because there are very few entirely 'uncontestable' monopolies (Baumol 2002, Dopfer and Potts 2008). A local or national government does have an effective monopoly on a range of services at a point in time, yet in a democratic system this monopoly will be periodically contested. Furthermore, leadership in the upper-management of such monopolies is also highly contestable, engendering implicit competition between aspiring managers in the creation and promotion of new ideas. Thus we have a puzzle. Governance is a service and, in a competitive or contestable environment, services must continually innovate to survive. Yet while it is now broadly accepted in principle and increasingly in practice that government services should aim for levels of efficiency on par with private sector organizations, there is little corresponding recognition that the parallel aim for innovation in government services that is on par with innovation practices and outcomes achieved in the market service economy is a fundamental contradiction. The goal of efficiency 'crowds out' the goal of innovation.

As such, a plausible explanation for the widely observed and much lamented deficit of innovation in government services is that it is a byproduct of the drive to efficiency and the elimination of both 'good waste' as well as 'bad waste'. In other words, in a system governed by public accountability that is premised on the achievement of efficiency and innovation you will either get efficiency or innovation, but not both. There are no simple solutions to this, although I will detail some possible ways forward that involve a re-assessment of what is meant and implied by public accountability. But first, consider why this is a non-trivial and non-convergent (i.e. endemic) problem.

3. AN EVOLVING ECONOMY REQUIRES EVOLVING POLICY

Economic growth and structural change is a 'normal process' that occurs when a certain minimal set of institutional conditions and freedoms prevail.

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