Tuesday, October 30, 2018

Bigger City, Bigger Bills

In brief ...
The last posting outlined rapid spending growth by Auckland Council since created by amalgamating seven units of local government and one regional council.  This post demonstrates that while rates increased only a little ahead of population growth, the boost in investment by the Council since it was created has been funded by growing charges for services and by borrowing. While the finances have been well-managed and debt remains reasonable, there is a question-mark over how long the rapid growth and cost of council activities can outpace the growth of the community and economy.  

This raises a number of questions. The key question: at what point will excessive council spending begin to limit the growth it aims to cater for? 

Keeping rates down

Auckland Council costs have gone up by around 26% over just six years by my estimate. Surely the ratepayers will be rebelling against that? 

Well, not necessarily. Over the same period, rates collected only went up 17% (in 2018 dollars), or 2.6% per year, roughly in line with population growth of 15%.  (That’s not to say they didn’t go up by more in some areas as the Council sought to equalise them across the newly formed city [1]).

But total council revenue went up a lot more, by 51% (in 2018 dollars, based on council annual reports). So, rates accounted for a falling share of revenue, dropping from almost half of the total in 2012 to 38% in 2018 (Figure 1).

Figure 1: Auckland Rates and Other Income, 2012-2018

Citizens are paying in other ways
Charges for local services went up by 44%, or $385m. Most of this is also paid by residents, who have little choice when it comes to water and waste or transport charges.  At the same time, development and financial contributions went up $108m or 150%. While this reflects city growth (and maybe some catch-up from development delayed while the Council was trying to sort out where growth might go), these are paid for mainly by home buyers (especially first home buyers): current and future city ratepayers. 

Figure 2: Main Components of Revenue, 20-12-2018

Building assets – and liabilities
Interestingly, vested assets accounted for 33% of revenue growth reported and 13% of total revenue in 2018 ($510m), up from just 2% in 2012.  Roads, sewer and water pipes (and pumps), reserves and parks, and so forth are transferred to Council at “fair value”as development proceeds .  They are reflected in the balance sheet as a component of non-current assets.

Vested assets are ultimately funded from new property purchase (in addition to development fees, also passed on in property prices).

One way or another, residents pay.

Vested assets are also an ongoing liability given the commitment to maintain them and fund their depreciation.  It is critical that they are well-placed and of a standard that will carry them well into the future if rates are not to escalate indefinitely.

Lifting investment
The Council’s accounts tell a story of recent growth. To better understand how growth is funded, and sidestep accounting conventions which see, for example, expenditure reflected in a reduction in the value of assets and vested assets recorded as revenue, it is useful to look at cash flow figures (Figure 3).

Figure 3: Auckland Council Cash Flow, 2012-2018

They indicate a 36% increase in revenue from rates, grants, fees, and charges between 2012 and 2018, supplemented by borrowings.  Annual borrowing declined significantly over the period, from 26% of cash in 2012 to only 6% in 2018. Presumably increased fees and charges have facilitated this, together with adoption of more diverse financial instruments, the latter reflected in the growth of the Other category (including dividends, interest, and $218m from the Crown in 2018). 

Keeping the lid on – so far
At the same time, the ongoing business of the Council is reflected in just 6% growth in the costs of suppliers and employees, compared with 21% growth in investment.  The fastest growing costs have been interest payments, more than doubling, although at this stage they account for only 10% of total spending (Figure 3). Annual borrowings (net of repayments) have trended down. 

Figure 4: Annual Borrowing and Interest Payments, 2012-2018

Long-term debt was up by $3.3bn (70%) in 2018, to $7.9bn, and total borrowings up $4.3bn to $10.8bn.  Increased indebtedness is reflected in the increased value of assets, up $13bn (35%) including revaluations,  to $50.2bn. Overall, ratepayer equity remained a relatively high 67% in 2018, although well down from an even healthier 74% six years earlier.
It’s not clear, though, whether this debt is doing much for the community. It needs to be.  Total borrowing per head of population (using StatsNZ June population estimates) grew by 76%, from $3,631 in 2012 to $6,384 in 2018. 

One way of charting the value of debt is to plot it against GDP, with the expectation that any improvements in public infrastructure and services might be reflected in output some time later.  The time span considered and a lag in the availbality of regional GDP data limits such an assessment.  However, short-term movements offer no evidence of a productivity benefit yet. Comparing June council debt with regional GDP 21 months later (possible only from June 2011 for debt to the four years to March 2016 for GDP) shows a 62% increase in debt compared with a 20% increase in GDP .  As measured by Stats NZ, Auckland's GDP growth was strong, but not as strong as the growth in the Council’s indebtedness.
Where to from here? 
The Council has kept the lid on its finances, despite the growth of debt, through moderately higher rates and sharply increased fees and charges.  This year it introduced even more ways to pay.  It is set to selectively tax income (on properties providing tourism accommodation) and mobility (levying road user charges over and above road costs which are already funded by the Government’s Road User Charges).
The Super City is delivering for the moment – at least in volume – but at what long-term cost? An appetite for increasing charges and growing debt to support rapid spending growth raises questions.  For example:

·        How much of the spending addresses the Council’s core business and how much is discretionary? And how is spending prioritised?

·       What is the quality of investment, both by the Council and by developers in new public infrastructure ? What are the long-term implications of the new wave of infrastructure for long-term spending on maintenance and funding depreciation?

·       What happens if population-based demand falls below expectations?  The high population projections justifying much of the current spending are by no means guaranteed.  If growth in resident numbers falls short, the surge in civic investment could stymie growth through the costs it imposes on households and businesses.

·      How well will current investments meet the expectations of future Aucklanders about how and where they will live, work, and play?.  Or, are we cementing current preferences into a future about which we have far-from-perfect knowledge?

·        At what point will residents and ratepayers resist rising monopolistic charges for public services? And how will such charges impact on the rest of the economy? 

·        In what ways is council spending impacting on regional productivity and output?

It is only eight years since the Council was formed but if a rapid increase in council costs is placing growth at risk, it may be timely to revisit the question of how Auckland is, or should be, governed. 

[1]              In Auckland the property rate charged is based on capital value -- land plus improvements -- and the consolidated council has been seeking to eliminate variations in the rate per dollar across the region

Wednesday, October 24, 2018

Auckland’s Super City and the Costs of Consolidation

This post sets out trends in the costs incurred by the Auckland Council over the past six years.  The Government created a single council plus subsidiaries model for the governance of the region in 2010.

The post starts with an update of the cost of employment growth in the new Council.  It then shows that under the new structure the rate of investment has been an even bigger driver of cost increases. Costs have clearly outstripped population growth, suggesting that the model adopted has not prevented the so-called super city from running into the diseconomies associated with excessive scale.

Early hopes – and risks
Problems reconciling regional infrastructure and environmental policy with local interests led to consolidation of one regional and seven territorial councils into a single “super city”.  Auckland Council was created in 2010 as a city of 1.44m people.  It was intended to reconcile competing territorial interests, rationalise public investment, align regulation and services, streamline processes, and achieve economies of scale. All this, it was believed , would make Auckland competitive on a world stage and lead to a “more liveable” city.
I questioned whether the reorganisation would achieve efficiencies, or simply lead to diminishing returns from increased organisational size and complexity. With eight years of the super Council behind us, we can consider how well it has worked. In this post, I consider cost performance.

But first, does bigger mean better?
(Skip this section if you just want to see the numbers).
Auckland’s consolidation was based on the premise that a bigger organisation would be better for a growing city.  But there are flaws in that assumption. 

As organisations grow beyond an optimum size, returns to scale fall and even reverse as efficiencies become outweighed by the shortcomings – the diseconomies -- of oversizing. Large producers and service providers may be impeded by ageing technology and legacy products and services, becoming vulnerable to competition from new entrants and innovators. Top-heavy management, entrenched processes and behaviours, structural and social complexity slow organisations’ responses to changing circumstances. Investment and operating practices become erratic as internal units pursue their interests without regard to the goals of the wider organisation or as they compete for internal resources.
We have seen organisational failures from excessive scale in manufacturing, aviation, construction, retailing, computing, IT, financial services, and others. Some large organisations may avoid collapse by transforming themselves into smaller units, a painful and not always successful process.  Others may be taken over, absorbed, or simply closed.  A few get bailed out. 

Large cities can also fail, when advantages of agglomeration are offset by increasing costs.  Businesses may suffer from the constraints of ageing and under-capacity infrastructure, increasing service charges, and rising land costs. Congestion and high house prices impact on employment costs and reduce a city’s attraction to new and existing households, leading to skill shortages.
Diminishing returns also apply to city councils.  And when large councils fall short, ratepayers pay. This may well be the case for Auckland if the Council’s costs run too far ahead of population growth.

The data
The figures used to explore Auckland Council’s costs are from annual reports.  Group costs are divided between the “core Council” and its subsidiaries[1]. The analysis is indicative, based on aggregate cost movements. All amounts are adjusted to 2018 dollars using the CPI.
An update on employment – onward and upward
My last post documented Council employment growth, especially in higher income brackets, from 2012 to 2017.[2]  The Annual Report to June 2018 is now available.  Here’s what happened:

Group employment growth slowed to 0.8% in 2018, compared with 3.4% average over the previous five years. The gain from 2012 to 2018 stills sits at 18%, though, (1,830 more employees), ahead of 15% population growth in the city.
Core Council employment[3] fell by 1% in 2018. 200 jobs were lost from the under $100,000 salary bracket.  Against this, the numbers in the $100,000 to $200,000 band were up 11.5% (140 jobs).

Here’s the rub: in 2018 employment in council subsidiaries and CCOs grew by 3.2% (150 jobs), with over half of this in positions paying more than $100,000 a year. Over the six years to 2018 employment in subsidiaries increased by 1,460 people (43%) with 35% among those earning over $100,000. In 2018 there were over 1,000 people earning between $100,000 and $200,000 in the subsidiaries, and 120 earning over $200,000.
Although employment growth slowed in 2018, higher paid jobs continued to grow. The result?  A 24% increase in the cost of employment ($168m) between 2012 and 2018.

It appears that council-controlled organisations are a Trojan horse –a vehicle for employment and salary growth a step removed from political control (Figure 1).  In 2013 they accounted for 33% of the Group workforce.  Today, they account for 40%, and for 47% of employees earning between $100,000 and $200,000, and for 82% of those earning over $200,000.  Subsidiaries and CCOs jointly accounted for 74% of the growth in Group employment costs.

Figure 1: Wage, Salary & Superannuation Costs, 2012 - 2018
This cementing in of high-end salaries reinforces my view that super City performance is likely to be impeded by the growth of a tier of management committed to keeping the organisation going as much as to achieving its community objectives. 

More people and higher salaries cement in higher costs.  But just how much do they contribute to an overall increase in council costs?  This rest of this post looks at what is happening to other council costs.
Costs: the bigger picture
Group operating expenditure grew 26% in real term from 2012 to 2018 (over $800m), ahead of the 24% increase in employment costs.  The biggest boost came from depreciation and amortisation[4], up almost $200m (30%). Nearly 70% of this was attributable to subsidiaries and CCOs (Figure 2). 

Figure 2: Expenditure by Category, Core Council and Subsidiaries, 2012-2017
The growth of depreciation reflects an increase of over $11bn in the Council’s property, plant and equipment portfolio (up 32%) from 2012 to 2018. A rapid increase in tangible assets is also reflected in repairs and maintenance spending (20% of the “Other” category in Figure 2), with annual costs up by 46%  ($84m) from 2012 to 2018 (Figure 3). 
Figure 3: Tangible Asset Values and Costs
A high level of investment commits the Council to substantial long-term costs. This is also the case with respect to property expenses, apparently responding to increased employment or newer, better-appointed offices to reflect the increasing salaries being paid: utilities, occupancy, rental and lease costs climbed by 79% ($69m).
In contrast, the largest category of Other spending, on goods and services, grew by just
10% (still up by $68m over six years, to $723m in 2018).  Only consultancy and professional services declined, by one third to $140m.[5]

Subsidiaries and CCOs grew more rapidly than the core Council in all categories other than finance costs. This presumably reflects the role of the core in funding increased civic investment and activity through its CCOs. 
Internal Transfers
This funding role is also evident in core Council spending on grants, subsidies, and sponsorships (GSS).  While the detail of transfers is not provided in the City’s annual reports, a large share are made to CCO investment and operations. Core Council expenditure on GSS grew by 65% from $623m in 2012 to $1,030 in 2018, 54% of the total increase in core Council costs over the period. 

The 2018 annual report identifies that around 88% of these payments went to the CCOs in 2017 and 2018, with Auckland Transport the principle recipient.

Conclusions and questions
Two obvious conclusions can be taken from this brief analysis:
·        Council costs are ramping up ahead of population growth, primarily through commitment to a substantial investment programme over the past six years, backed by an increasingly expensive if not expansive workforce.

·        Reliance on a CCO model in the consolidated council has been central to the increase in employment, investment, and related costs. In 2018 CCOs and subsidiaries account for 70% of council investment in property, plant and equipment ($32.7bn).  
In light of these conclusions, it is interesting that the Royal Commission on Auckland Governance put budgeted operating costs across eight councils in 2008-09 at close to $2b and capital investment at $1.25bn.[6] In 2018 dollars this is around $2,600/head of population. It compares with $4,580/head in 2018, a 76% increase in just ten years! 

Given these observations, determining the efficiency and effectiveness of the Council's increased spending clearly requires analysis of the individual CCO accounts. A number of questions need addressing, among them:
·        Does the spectacular growth in council costs result from a prior failure to meet the city’s needs? Does it reflect a fundamental change in the direction and scope of council activity? Or has the organisation simply over-stepped the threshold of efficiency? 

·        Do the CCOs enhance the effectiveness of the Council, and local democracy? Or are they reducing the accountability of the Council at the same time as it increases the scope, scale, and quality of its investment?

·        Is a governance model that focuses on functional specialisation at a regional level rather than on local priorities, appropriate for a diverse and growing city?

And, of course, who pays, and how?  This is the subject of my next blog.  

[1]           Subsidiaries include five Council Controlled Organisations (CCOs), Ports of Auckland Ltd, and Auckland Council Investments Ltd.
[2]           2012 rather than 2010 is used as the base year to provide for the costs of reorganisation before then, and because of more consistent and therefore comparable reporting.
[3]           The core Council conducts those functions not delegated to Council Controlled Organisations or performed by subsidiaries
[4]           Depreciation is applied to tangible assets, amortisation to intangible assets
[5]           It might be argued that the reduction of $67m in fees goes some way – but only some way - towards offsetting the $157m boost in wage and salary costs
[6]           Royal Commission on Auckland Governance (2009) Volume 1, Executive Summary p15, Department of Internal Affairs

Monday, October 1, 2018

Supersize my City: Super for Some

Is it the growth we want?

I have been thinking about the increasing cost of Auckland Council.  Is it simply a sign of growth, or is it something to do with the nature of the large councils (or large organisations in general)? And if it is all about growth, it raises other questions that remain unanswered, questions of physical and social capacity. Is it about coping with something that seems inevitable? Or is it something that the community wants and can embrace?  And if so, what will happen when that growth slows?
And how does the growth we are experiencing align with the much-touted ambition to be the world’s most liveable city?  (And what precisely does that mean?) There is a risk that we have leapt to the answers without quite understanding the questions. 

Another question

There’s another elephant on the Isthmus, one I turn to here. Can we sustain the costs of a super-sized council created to combat the supposed inadequacies of smaller councils? As the Council seeks out new sources of revenue, will they be enough to head off the fiscal headwinds that the Council may encounter, especially as the costs of living in Auckland increase?
If, as was hoped, a single city was to be more streamlined and efficient, this should be evident in its employment performance. I concentrate on council employment and its costs in this post. To do so I returned first to an analysis I have undertaken before (in 2014 and 2016).  Now that the super city has been with us for eight years the numbers should be more settled.

Employment growth: onward and upward

The amalgamation of six separate territorial authorities and a regional council (including the Auckland Regional Transport Authority and Watercare Services) was aimed at savings through integration and economies of scale.
Gains on the employment front from amalgamation were short-lived, however.  Stats NZ showed employment figures soon back above trend as indexed growth in Auckland moved ahead of the rest of the country (Figure 1). 
Figure 1: Local Government Employment Growth, Auckland and the Rest of New Zealand, 2000-2017
Source: Business Demographics, Statistics NZ

It gets worse when we look at the annual June reports for the Council since 2012.  They show significantly more employees when the subsidiaries – the CCOs – are accounted for:

Figures from:
Auckland council (June Reports)
Statistics NZ (as at February)
Difference (rounded)
 Source: Auckland Council Annual Reports; Stats NZ Business Demographics
Interestingly, the dip in 2016 in Statistics NZ figures does not show up in the Council’s data. This is preumably influenced by the fact that some of the Council's service delivery functions (water and waste, for example) turn up in other sectors. 
However, it turns out that employment growth has taken place primarily in Council's subsidiaries. Consider the staff figures for the period 2012 to 2017:

Share of Gain
Core Council Staff
CCOs' Staff
Total Group
CCOs' Share

Source: Auckland Council Annual Reports
While growth within the “core Council” has trailed population growth (6.3% compared with the Stats NZ estimate of a 7.2% population gain), the CCOs have grown much faster.  They accounted for 75% of employment growth in the Group, reaching almost 40% of the total. The result: overall council employment increased at more than twice the rate of population growth.  It was also well ahead of 5% inflation since 2012.  
On employment grounds council growth is easily outstripping the growth of the city.

The cost of council employment

Even if wages and salaries stayed constant, the prospect of savings in employment costs from combining councils was astray. Annual reports show growth in the cost of council employment (“Employee Benefits” including contributions to superannuation, provisions for redundancy, and the like) increased 24% from 2012 to 2017 across the Group. The subsidiaries, the CCOs, grew employment costs by 45%; the core Council by a more modest 12%, although this was still twice the rate of growth in Auckland's employment.
Figure 2: Employment Costs, Auckland Council and CCOs, 2012-2017
  Source: Income and Expenditure tables, Auckland Council Annual Reports
Across the Group, employment costs were $853m in 2017, $163m up on 2012.  So much for $66m in staff savings ($74m in 2017 dollars) touted in 2010 as justifying the super city.  . 

Super city, super salaries

If the workforce growth that took place had been at stable incomes, the cost of employment would have been $481m for the Council and $330m for the subsidiaries, $811m.  This leaves an additional $42m attributable to wage creep after inflation ($27m in the core Council and $15m in the CCOs).
How did this happen? Well, Bernard Orsman in an article in the New Zealand Herald last year put his finger on it:
“One in five staff at Auckland Council is earning more than $100,000 as the wages bill for the Super City blows out for the third year in a row.
“…  the number of executives earning more than $200,000 has increased by 25 per cent in the past year, from 155 to 194, according to figures in the council's 2016-2017 annual report”.
“The council and its six council-controlled organisations (CCOs) employ 11,893 staff, of whom 2,322 earn more than $100,000”.
Changes in these figures since 2012 reveal some interesting developments (Figure 3).
Figure 3: Shares of Salaries $100,00: Auckland Council 2012-2017
 Source: Auckland Council and CCO Annual Reports
First, growth in the core Council occurred entirely in the $100,000-plus bracket, rising from under 10% to 16% of employees while those earning less than $100,000 declined. This means that all growth in employees earning under $100,000 a year took place in the CCOs. Is this a sign that the core Council is already suffering organisational ossification (entrenching people, systems, and values as the outside world continues to change)?
Second, while 1,500 people in the core Council earned between $100,000 and $200,000 a year in 2017and 70 over $200,000, a disproportionate share of high salary growth took place in the CCOs.  By 2017 there were around 1,100 people earning $100,000-$200,000 in CCOs, up 48% since 2012, and 120 earning over $200,000, up 62%.
Not only has absolute employment growth focused on the CCOs, but they have provided fertile grounds for supersizing salaries, leading to significantly higher average wages compared with the core Council by 2017.  This is despite growth in the latter taking place entirely at the higher end of the salary scale.
It seems that both the council and its subsidiaries have been busy uploading salaries as well as people

Even more questions

While council reports are full of measures of progress and performance, there are still some outstanding questions.   

For example: 
  • Can we justify this growth in employment costs by increased productivity?  
  • Maybe we need to look at the bigger income and expenditure question?
  • Did we simply replace territorial fragmentation with functional fragmentation?
  • And where are the governance and efficiency gains for local democracy in that?