Auckland’s Super City and the Costs of Consolidation

Synopsis
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

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:	2012	2013	2014	2015	2016	2017
Auckland council (June Reports)	6,789	7,008	7,051	7,123	7,184	7,220
Statistics NZ (as at February)	5,000	6,600	6,800	7,400	7,600	6,400
Difference (rounded)	1,790	410	250	-280	-420	820

 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:

	2012	2013	2014	2015	2016	2017	Gain 2012-17	Share of Gain
Core Council Staff	6,789	7,008	7,051	7,123	7,184	7,220	431	6%
CCOs' Staff	3,368	3,608	4,071	4,257	4,407	4,673	1,305	39%
Total Group	10,157	10,616	11,122	11,380	11,591	11,893	1,736	17%
CCOs' Share	33%	34%	37%	37%	38%	39%	75%

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”.

and

“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? 

Can we do Bigger Better? Firm Size and the Quest for Productivity

Big enough to prosper

Look at this from the Economist:

Britons and Americans are used to lionisations of the small businessman. This praise is often misplaced; it is not so much small firms that drive growth and job creation so much as small and young firms on their way to becoming much larger. Where small firms are most common, as around Europe's southern periphery, their prevalence is sign of uncompetitive markets and low productivity.

The Economist suggests that the key to productivity is letting companies grow, because bigger companies deploy capital and labour more effectively.  We might add, from our remote New Zealand perspective, that size also gives firms the ability to work offshore markets, expanding beyond a constrained  domestic market.  

In this way, size begets size.  And big firms provide the seed bed for innovation (as I argued in Growing a productive urban economy) creating a virtuous cycle - at least up to a point. (For very large organisations there often comes a time when management diseconomies reverse efficiency gains).

What Role SMEs?

In New Zealand we extol the small and medium enterprise sector (SME) when maybe we should be doing what we can to get SMEs to bust out and grow.  And it’s fashionable to argue that if more were to locate within Auckland– our primary city - businesses could reap external economies of scale (so-called agglomeration economies), accessing more labour, more skills, and more services.   

But it’s more fundamental than that.  Rather than promoting lots of small business units sharing services and competing in a crowded labour market we really need to do what we can to ensure that more are actually growing.

The Size of New Zealand Business Units

The rest of this post looks at the size distribution of New Zealand business units using Statistics New Zealand February 2011 data. It then looks for evidence that location in Auckland might favour manufacturing by favouring bigger firms. 

The statistics tell us that 65% of New Zealand’ Geographic Business Units didn’t employ anyone.  (A GBU is defined by Statistics New Zealand as “a separate operating unit engaged in New Zealand in, or predominately one, kind of economic activity from a single physical location or base.) Let’s set them aside.

So what about the other 35%?  Well, the bad news is that New Zealand’s business units are underwhelmingly small.  63% of them provide 5 or fewer jobs, 78% fewer than ten! 

Looking at the other end of the spectrum, of 175,150 GBUs only 2,425 (1.4%) employed more than 100 people, and another 3,540 employed between 50 and 100 (2.0%).  Between them, though, these bigger units provided 44% of the country’s jobs.

The Analysis

I looked at the size distribution of business units for two “regions” – Auckland (New Zealand’s only city of over 1 million people) and the rest.  Auckland accounts for 29% of the country’s business units and 33% of its employment. 

I plotted the share of GBUs and employees across six size categories for Auckland and the rest of New Zealand.  The share of  business units in a given size category is plotted in the first two bars and the share of employment in the second two for each of the six size categories.  And in each case the share of the country’s units or employment outside Auckland (Rest of New Zealand) is plotted first ( in blue), to the left of the share inside Auckland (in red). 

So what does the data tell; us?  Business units in Auckland tend to be slightly larger. Even though over 75% still employ fewer than ten people (compared with 78% elsewhere) there is a marginal bias towards larger organisations, with 35% of Auckland jobs in units employing over 100 people compared with 31% for the rest of New Zealand.

This is consistent with the propensity of businesses in a dominant city to be larger, given a labour resource that can support greater expansion and a larger local market.

Digging Deeper

This exercise has been repeated for manufacturing, and within manufacturing for the dominant food processing sector (67,850 employees nationally) and for the next three sectors, equipment and machinery manufacturing (26,060 employees), metal products (21,650), and wood products (15,970). The charts appear at the end of this post.

Manufacturing

In manufacturing the picture changes.  The rest of New Zealand category has a greater proportion of both small and large enterprises than Auckland.  Consequently, only 32% of Auckland’s manufacturing employees are in firms with over 100 employees, compared with 42% elsewhere in the country.

Apparently the benefits of urban scale do not translate into larger manufacturing enterprises, at least at this level of generalisation.  This  raises doubts over the productivity of firms in the city,  and is consistent with my earlier evidence that concentration of a sector in  Auckland does not necessarily favour its growth .

Food Manufacturing

This anomaly is explained in part by the nature of the food products sector, which accounts for 36% of all manufacturing employment in New Zealand.  It is dominated by large dairy and meat processing works in rural areas, small towns, or provincial cities.  The nature of these long-standing and globally competitive primary processing activities mean that efficiencies accrue outside major urban centres in factories that tend to be labour, land, and capital intensive. 

Wood Products

Wood product manufacturing is much the same.  The 21% of New Zealand’s units located within Auckland tend towards medium size (10-50 employees).  Elsewhere in the country 27% of units of employ over 100 people.

So scale, expertise, and a commitment to exporting in primary processing mean that productivity in manufacturing may be healthiest outside  Auckland.  It is also reflected in a heavy commitment to exporting from  secondary centres.  Despite concerns that New Zealand food and wood processing do not produce a lot by way of highly transformed, high value products, sustaining and promoting their scale outside the main urban areas has been critical to their continued competitiveness.

Certainly Auckland (and Christchurch) plays an important role in these  industries, first through housing  higher order or specialised services they might draw on, including logistics, finance, legal services, and research; and, second, as a  location for smaller spin-off firms that undertake more specialised manufacturing and marketing using primary products as their raw materials.

The urban manufacturers

What about sectors that entail a greater degree of product transformation? Metal product and machinery manufacturing fit this description and are, by contrast with primary processing, urban activities.  In New Zealand, though, they are modest both in scale and performance. With a small number of notable exceptions there are few units capable of competing internationally.

Metal product manufacturing tends to take place mainly in medium-sized units, from 10 to 100 employees, particularly in Auckland, which dominates the sector.

The manufacture machinery and equipment has a higher proportion of very small units, and more employees in the small number of large units.  Again, Auckland accounts for a disproportionate share of national business units and employment.

The size distribution of units in these sectors, then, may be tied to the  scale of the  markets they are located  in – making them relatively poor prospects for productivity-driven international sales.  Their capacity to move beyond small scale is most likely limited.

So what does it mean?

If scale is a condition of productivity (and exporting), New Zealand industry faces a major disadvantage.  That’s hardly news.  So far, it has not achieved a lot by way of global performance outside primary processing sectors where scale and accumulated expertise build on a natural production advantage.  That’s not new, either. 

Making the point that in New Zealand size, innovation, and productivity happen outside Auckland is an important reminder, though, that much as we might want to pursue planning and policy fads based around urban agglomeration and density, that’s unlikely to offset our intrinsic disadvantages of small scale and remoteness. 

So what can we do?
According to the World Bank rankings New Zealand is already third in the world for ease of doing business.  Perhaps the answer is to ensure that it is also easy to grow a business here. 

Among other things, a policy fixation which promotes places as the fonts of productivity and innovation – and Auckland as the solution to boosting New Zealand’s economic standing -- may have to change.  The reality is that productivity is associated with organisations –  large and growing organisations, and their capacity to engage in networks ("production and distribution chains") of growing businesses.

The challenge for urban policy makers is to ensure that local conditions, the rules, regulations, and charges  affecting firms, and  the quality and availability of land, labour and capital  do not impede local investment and growth.  How this might be done should  be central to the Auckland Spatial Plan.  I see little evidence that it is.