Treasury has been haemorrhaging talented economists for years and the budget leaks were just the tip of the iceberg for a department in crisis, writes Eric Crampton of The New Zealand Initiative.

If the Canterbury earthquakes taught us anything, it’s that the immediate response to a disaster is a very different thing from the rebuilding that has to follow.

Disaster response is about triage, the good-enough, and avoiding substantial further harm. The rebuild is different. It takes a fair bit of thought about what the place should look like, and a long-term strategy to get there. In the best case, the long-term vision has always been in place and all that needs to be done is working out how to get there from the current mess. But it can be a lot harder if there were a lot of longer-standing issues prior to the disaster that also need to be resolved.

The state services commission’s investigation of treasury secretary Gabriel Makhlouf’s conduct and statements during last week’s unauthorised access to budget documents is disaster response. But this disaster was not the Christchurch earthquake, and the IT department is the least of treasury’s issues. Last week’s mess is the culmination of years of mismanagement that saw the substantial erosion of treasury’s competence, to the point where treasury’s fundamental reason for being has been put at risk.

Treasury needs a recovery, and a rebuild. The job facing any incoming chief executive will be exceptionally challenging.

But let’s walk it through.

Treasury core function is to be the government’s lead economic advisor. It exercises a broad range of responsibilities, but it isn’t unreasonable to view the most important one as advising the government about trade-offs. Policies have a wide range of costs and benefits; providing accurate advice to the government about the likely consequences of policies, both intended and unintended, within a framework allowing a weighing up of different policy options, is incredibly important.

As a central control agency, treasury is in a particularly important position relative to other ministries. Every ministry will view its own spending proposals as particularly meritorious. There are near-infinite numbers of programmes that could be developed and deployed, many of which would do at least some good. Regardless of your views on the appropriate level of tax, budget constraints must ultimately bind – even if the government massively expanded the amount of money it collects, it would still have to decide among competing ways of spending the last dollar collected. The minister of finance must help cabinet assess priorities.

And that’s where treasury comes in. As a state sector ‘control’ agency, it runs a level ruler across the competing policy proposals. If all is working well, a rigorous analysis helps ensure that every dollar spent by the crown provides the greatest possible public benefit. That does not always happen, as cabinet may have an eye to net political benefits. But treasury can at least assist its minister in assessing the trade-offs from a public interest perspective: some politically-inspired policies are more costly than others.

That discipline, when supported by rigorous treasury analysis and backed by cabinet decisions to focus spending in the areas that do the most good, can provide a self-reinforcing virtuous circle. Ministries then know that the best way to secure funding for their priority areas is by putting up rigorous, credible proposals demonstrating the benefits of their policy. Treasury vets the proposals, holding them to a high standard. Cabinet approves the proposals that survive the process. And the loop is then closed with post-implementation reviews checking whether spending and regulatory programmes have panned out as expected, or whether resources should be redirected to more promising areas.

Treasury’s core job, then, isn’t to be besties with all of the other ministries. Good relationships are important, and make the job a lot easier, but delivering credible and rigorous advice to the government is priority. Sometimes government will not want to listen, and that is the government’s prerogative. But even in that case sound assessments, if published, help Parliament and voters to hold the government to account.

Treasury is failing in that role and nobody else can do it.

I don’t know when that all really started going wrong on Treasury’s end, but I know when I noticed it going wrong. It started with something trivial, as these things often do.

On 22 November 2015, Treasury Secretary Makhlouf penned an op-ed for the National Business Review lauding the merits of diversity. All well-meaning and nice-sounding stuff, who could possibly be against it? But the Secretary wrote “international research shows companies that have a balanced representation of women and men on their boards perform better.” As I was rather familiar with the academic literature in the area, I was curious on what research the secretary had drawn. When I asked, treasury cited a couple of consultancy reports that made no serious attempt to deal with some of the trickier statistical issues at play. These suggest that while women are great directors – they show up more, and are more likely to join committees – diversity alone has either no impact or a negative impact on firm performance. What the research does show is that firms which value diversity tend to be broadly well-managed and governed, and thus out-perform the average, and that firms with weak governance benefit from diversity on their boards.

It’s trivial in the grand scheme of things, but it was a worry: the secretary of the treasury was weighing in on a politically contentious issue, and rather than provide the kind of dispassionate weighing up of complex evidence his position demanded, he reached for politically convenient but statistically glib consultancy reports for use in an op-ed format.

2016 brought far greater worries. But I’m afraid I need to provide a bit of back-story. During the time I was on faculty in economics at the University of Canterbury, from 2003 through 2014, treasury and the reserve bank fought over our best and brightest honours graduates. Every year, prior to starting honours, the best of the cohort would spend the summer on an internship with either the bank, or treasury. And every year the two most prestigious public sector employers of economists would make earlier and earlier employment offers to make sure they had their pick. Other Ministries knew it was pointless to extend an offer to a promising Honours student too early, as top students would be waiting to find out whether they had an offer from the reserve bank or treasury before entertaining others.

And so, in August of 2016, when a friend emailed on behalf of his son, then completing a masters at Canterbury, to ask about the employment environment at treasury, I naturally suggested he ask any of his classmates who had completed the treasury internship. But things had changed since I left. Canterbury’s best students had stopped seeing treasury as a place that was interested in economics or in hiring economists. Graduating students questioned whether treasury wanted to hire any economists at all.

More senior Treasury officials I advised about the problem appeared to take those concerns seriously, with changes to who undertook the graduate recruitment efforts at the universities. But in November 2017, Treasury celebrated having been awarded Deloitte’s IPANZ Public Sector Excellence Award for a blinded graduate recruitment process that resulted in no hires with qualifications only in economics. It would of course be silly for treasury to hire only economists, but recruiting no graduates with a sole focus in economics, when Treasury was losing senior economists, created the opportunity for a substantial erosion in core skills.

So I went to work under the OIA to try to figure out what had been happening. I also started checking other measures of treasury’s performance. And things looked increasingly grim.

While 10 of 15 graduates recruited in the 2019 graduate recruitment round had some background in economics, only four had at least honours-level training in economics or finance. The recruitment process did little to distinguish candidates with a minor in economics from those with a masters or honours degree. And Treasury’s in-house training programme is simply not up to the task of making up for those deficiencies.

Very recent reports suggest stronger efforts to hire in economists, but the deficit is now large.

Among those staff with known qualifications, relatively few have appropriate training in Treasury’s core business. An OIA response I received last year suggested economists are outnumbered among the analysts – at least among those whose qualifications were known.

Over the past six years, from 2013 through 2018, Treasury has seen a net loss of 18 economists with honours or masters-level training, and a net loss of five with PhD-level training.

It’s consequently little surprise that Treasury’s annual reports reveal declining measures of the quality of Treasury’s policy advice since 2012/2013. Performance for 2017/18 was so bad that it included a footnoted apology in the 2018 Annual Report, noting a continued need “…to ensure economic perspectives are fully covered.” Treasury analyses should not fail for want of economic content, and yet here we are.

And the decline has not gone without notice.

Where Treasury had released its 2015 External Stakeholder Survey within a couple of months of its receipt, Treasury sat on its 2017 External Stakeholder Survey for almost a year and released it only under substantial pressure from me. The survey showed declining stakeholder satisfaction on every single key result.

More worryingly, among those interacting with Treasury on core business of economics, macroeconomics, and fiscal projection, satisfaction dropped from 70% in 2015 to 47% in 2017. The proportion of stakeholders viewing Treasury staff as well-informed dropped significantly, as did overall confidence that staff do a good job. Lifting the quality of Treasury staff was near the top of the list of stakeholder priorities, with one highlighted response noting that “Treasury staff are personally a pleasure to work with, but they don’t have a strong background in economic analysis.”

It is very, very easy to find former Treasury staff, now employed in other Ministries or in the private sector, who will attest to the diminished value the organisation has placed on rigour and expertise. Once you start being the guy who notes and criticises Treasury’s decline, a lot of people who have been bottling up frustrations for rather some time start coming out of the woodwork for a sympathetic shoulder. And then you start having to be very careful lest a vengeful Treasury run system audits to figure out who has been talking to you this time.

I have no view into processes in IT at Treasury; it will be interesting to see whether Makhlouf received bad advice about the data breach, or whether he provided his own spin on things. But I do note that IT, until just a few weeks ago, came under the responsibility of Fiona Ross as Deputy Director of Operations. You will remember her as co-sponsor of the wellbeing card game about which Danyl McLaughlin recently reported. Rigour and competence have not seemed to be Treasury’s driving priorities; it could be that last week’s IT mishap is another symptom of the larger issue, or it could just be the kind of screw-up that can happen too easily in IT.

The problems are also evident in the much-promoted wellbeing framework. Done properly, the framework would provide an extended form of cost-benefit assessment incorporating a broader range of costs and benefits into the calculations. Programmes would be evaluated against that broader cost-benefit framework, both when policies are proposed and when evaluated in post-implementation review. But too much of Treasury has taken a qualitative approach to wellbeing that seems actively hostile to rigourous analysis. The framework did not prove ready to provide the kind of wellbeing budget for which we might have hoped.

And it isn’t as though Treasury only started working on this with the change in government: the wellbeing focus even predates Secretary Makhlouf, dating back at least to about 2010 under then-Secretary John Whitehead. At first it seemed mainly to be a marketing exercise to find a vocabulary more palatable to a future incoming Labour government; Treasury still stung from Finance Minister Cullen’s dismissal of Treasury advice as ‘ideological burps’. But the project metastasized from there, with volumes of working papers and a dashboard of indicators. Treasury has been working on its wellbeing framework for years and has achieved very little. The 2019 Budget increased spending by billions of dollars in prioritised areas, but without any framework either assessing the likely wellbeing benefits or evaluating whether those benefits eventuate. The primary effect of the wellbeing focus has been to diminish rigour in Treasury analysis.

And let me now scare you a little bit more.

All of the problems I’ve so far described are problems in the normal day-to-day drill at Treasury. When the next economic crisis comes, as it inevitably will, the government will likely have to make major decisions, some of them in the space of hours. At stake will be the jobs of thousands and billions of dollars of value across the economy.

As the lead economic advisor, Treasury will be on the front line for advice. The depth of its expertise in economics and finance will strongly influence the quality of the government’s response. There will not be time to learn the relevant literature or to study the relevant problems – as a less trained junior staffer might do during a normal policy cycle. Staff will either be able to quickly think through how best to respond based on a broad and deep knowledge of the field of economics, or they will not. And getting it right will matter.

All of that leaves an incoming chief executive with a monumental task.

Treasury needs to rebuild core competence in economics. To do that, it needs both to be and to be seen to be a place that values rigorous economic analysis as critical to its role as lead economic advisor. Strong economics graduates need to see Treasury as a place where their contributions would be valued. Many in Treasury will point to the difficulty in hiring good economists in a small market, but I remember when Treasury was the place where our best dreamed of being despite the poor salary relative to the private sector. Economists who wanted to make the country a better place chose treasury when treasury was a place that valued economics.

It can be that place again. But that rebuilding will require substantial changes in Treasury’s senior leadership, beyond the Chief Executive. A fish rots from the head, but the rot works its way down if the thing is left out in the sun too long.

How did HR at Treasury manage to run the kind of recruitment processes it has been running for so long? Did impetus from that come from staff within HR, or direction from above?

Just why were some of treasury’s most competent economists driven from the building, and by whom? There are pockets of excellence that remain at Treasury. What can we learn from where those pockets are? Any incoming chief executive would be very well advised to read carefully through treasury’s 2017 internal staff survey which very clearly testified to the diminished standing in which expertise is held within the organisation.

There is an additional overarching worry. Just how did state services commission processes lead to the appointment and the more-inexplicable reappointment of Makhlouf in the first place? Both may reflect SSC objectives, and are a concern when we consider the current appointment process.

Rebuilding treasury’s capability and credibility must be the critical task for a new Chief Executive. Treasury needs much more than a pair of steady hands who might stay its current course. It requires an exceptional candidate.

It needs someone whose credibility as an economist can visibly demonstrate the organisation’s commitment to rebuilding capability in its core responsibility as the government’s lead economic advisor. It needs again to be the place where New Zealand’s best economists want to work, rather than one that is the object of derision. And it needs a Chief Executive with the public sector and managerial skills to make the staffing changes at senior levels necessary to start fixing the problem.

It will be difficult to find that unicorn candidate. An interim CE may get treasury through the current disaster response phase. But the recovery and the rebuild from what Makhlouf has wrought over the course of his tenure as secretary is a much bigger, more difficult, and fundamentally more important project.

Dr Eric Crampton is chief economist with The New Zealand Initiative. He previously served as Lecturer and Senior Lecturer in Economics with the University of Canterbury, where he taught public economics, and where he maintains an Adjunct Senior Fellow affiliation; he also has lectured in public economics with the School of Government at Victoria University of Wellington.