Section 4 Challenges in Aiming for Small Government

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This section presents an overview of the ongoing shift from "the public sector to the private sector," focusing on the initiatives currently under study relating to opening up the publicly regulated market and market tests. The section also considers the measures required to enhance the benefits of the shift from "public to private sector" and to overcome the various challenges that will arise from the shift.

1. Strengthening Initiatives toward Opening Up the Publicly Regulated Market

A shift from "public sector to private sector" will contribute to enhancing the efficiency of business and expanding the range of choices available to consumers. Judging from the experience of other industrialized countries, the introduction of measures aimed at a shift from "public sector to private sector" involves more than standard work operations or the establishment and management of facilities. It also means producing results in a wide range of fields. In Japan, in the fields that constitute the so-called publicly regulated market, including medical care, nursing care, education and child-care, studies are underway for increasing the choices available to consumers, and introducing private-sector expertise. In addition, to give concrete form to the shift from "public sector to private sector," model projects have been implemented on a trial basis in FY2005 with a view to full-scale introduction of "market tests" (public-private competitive bid system). At the same time, systems, including a legal framework, are being set in place as specified under the Improvement of Public Services Efficiency Bill (or Market Testing Bill) (provisional title).

(1) Status of initiatives and consideration in individual fields

Significance of opening up the publicly regulated market

The reform of the so-called "publicly regulated market," in which public involvement exerts a strong influence by means such as limiting service providers to certain corporations and enterprises, has been under discussion principally by the Council for Regulatory Reform and its successor, the Council for the Promotion of Regulatory Reform. In special zones for structural reform and in other locations, progress is being made in opening up the publicly regulated market to the private sector in some fields, albeit with conditions attached.

Generally, in the fields of medical care, nursing care, education and child-care, there is strong public involvement concerning participation and the nature of the services provided. These public services are associated with the basic right of equal opportunity regarding the life, health and education of citizens, which the central government must directly guarantee to a certain extent. Because the information available to these public service providers and users is asymmetric, users sometimes have difficulty making appropriate choices, as in the case of medical care where patients are unable to determine the extent of treatment appropriate in order to alleviate a specific disorder. In addition, much of the cost of these public services is covered by public insurance and subsidies, and there is concern that in situations where provision of services could become excessive, the fiscal burden would increase substantially. However, the characteristics of a publicly regulated market do not necessarily disallow the opening up of the provision of these services to the private sector. From the perspective of guaranteeing equal opportunity to life, health and education of citizens, a minimum of public regulation is required, but regulation could be relaxed by shifting from ex-ante preventive-type regulation to ex-post regulation depending on the characteristics of the field to be regulated. The problem of asymmetrical information could also be dealt with by replacing existing regulations with regulations that require full information disclosure and evaluation by third parties, regardless of whether the service provider is government or the private sector. At the same time, the fiscal burden associated with excessive provision of services could be eased by controlling demand through provisions that require, in an appropriate manner, that users shoulder a portion of the cost burden.

The participation of joint-stock companies and other private-sector businesses offers several advantages of opening up the publicly regulated market to the private sector concerning the provision of public services. It promotes competition between businesses and thereby reduces the cost of providing services. It also improves management efficiency through the introduction of business administration expertise. In addition, it allows service provision to be matched to the needs of users through private sector inventiveness, and generates a diversity of choices. The state of progress of reforms in the main individual fields concerning the relaxation of regulations on participation and the expansion of consumer choices is discussed below.

Relaxation of regulations on participation

In fields such as medical care and education, the participation of profit-seeking business entities such as joint-stock companies has not been recognized up to now from the standpoint of issues of business sustainability and ensuring service quality, but a partial opening is now in progress, centering on special zones for structural reform (Table 2-4-1).

Table 2-4-1 Status of relaxation of regulations on participation into the publicly regulated market

Starting with the medical care field, participation by joint-stock companies in hospital administration is recognized in special zones for structural reform under the partial amendment of the Special Zones for Structural Reform Law of October 2004. However, the medical care specified under this amendment is limited to care not covered by insurance protection and to "advanced medical care," and participation in medical care provision covered by insurance is still not recognized. Moreover, with regard to applications for authorization of special zones for structural reform, there were no applications from local governments as of the seventh authorization in March 2005 and only one application as of the eight authorizations of May 2005. In addition, while capital participation by joint-stock companies in medical care corporations is itself possible, legal restrictions also exist that do not allow the participating company to become a partner.

The establishment of schools by joint-stock companies or by NPO corporations that provide education for truant elementary, middle and high school students has been recognized by an amendment to the Special Zones for Structural Reform Law in 2003 in the case where the local government deems that there is a special educational need. In 2004, four schools including a middle school, a high school, a university and a graduate school were established under the administration of a joint-stock company, and education commenced taking advantage of the special characteristics of a joint-stock company, etc. However, even if the educational services provided by schools administrated by joint-stock companies or NPOs in special zones for structural reform do not, in themselves, differ significantly from conventional schools using other service formats, such schools, it has been pointed out, are entirely outside of the scope of public aid.

With regard to schools established by the public sector and administered by the private sector in special zones for structural reform, local governments provide the necessary support to high schools and kindergartens for basic property such as school grounds and buildings and expenses required for operation, and also to establish public and private cooperative school corporations involved in approving operation plans and budgets. However, schemes for blanket entrustment of the management and operation of public schools to the private sector under contract are still the subject of study, in which a broad direction of approaches concerning the basic method for entrusting school administration to the private sector continue to be taken into account.

With regard to nursing care, the introduction of a nursing care insurance system from FY2000 has encouraged many private businesses to enter the field, particularly in the area of home nursing care. On the other hand, nursing care provided in facilities such as special nursing homes for the elderly has continued to be subject to regulation relating to participation, even after the introduction of nursing care insurance. In special zones for structural reform, however, approval was given in 2002 for the participation of joint-stock companies in special nursing homes for the elderly operating under public-establishment, private-management schemes or PFI in which local governments are permitted extensive involvement. However, when participation by joint-stock companies has been approved, actual participation may be subject to limitations where conditions apply to net asset amounts or to succession by another corporation upon withdrawal from business.

Day care centers are regulated under uniform nationwide standards for establishment and administration and classified into either authorized day care centers or unauthorized day care centers. The current participation regulations that restrict entities establishing day-care centers will be discontinued from 2000, even regarding authorized day care centers, which will allow joint-stock companies to participate. In some cases, however, participation by joint-stock companies is essentially not recognized by local governments, and the fact that it is possible to authorize a blanket entrustment to the private sector of operation of public day care centers is not known to a sufficient degree with respect to local government.

Combined use of insured medical care and uninsured medical care (restrictions on "balance billing")

The issue of combined use of insured medical care and uninsured medical care when applied to individual cases from the patient's point of view includes instances where the cost burden not covered by insurance is excessive and where the patient's urgent needs cannot be fully addressed with accuracy. This problem has been the focus of an energetic debate conducted from the perspective of ensuring people's safety, preventing increases in patients' burden, expanding the choices available to citizens and increasing convenience. As a result, in December 2004, a basic agreement concerning the problem of "balance billing" was established (by the Minister of Ministry of Health, Labour and Welfare and the Minister of State of Administrative Reform, Special Zones for Structural Reform, and Regional Revitalization). This agreement sought to reconstitute the current system as a new framework following a radical review concerning the appropriate modality for combined use of insured and uninsured medical care. It was guided by the concept of national insurance as a system available to all citizens that ensures necessary and appropriate medical care basically through insured treatment and considered whether or not evaluations for introducing insurance will be performed in the future.(46) Reforms based on this perspective are going forward for swift authorization of combined insured and uninsured medical care relating to medicines not approved in Japan such as anticancer drugs and to advanced technology.

Quantitative effect of private sector participation in the government market

The anticipated benefits of participation by private businesses such as joint-stock companies include improvements in efficiency and expansion of the choices available to users. In this connection, the Cabinet Office (2003b) contained an analysis concerning the degree to which participation by private business enhances productivity.

To examine productivity in medical care, a model was devised whereby output was defined as the number of patients treated per month, and output was explained in terms of productivity, capital input and labor input. The results of estimates indicated that productivity of private hospitals is 37.9% higher than public hospitals (Figure 2-4-2). It was not possible to directly measure the difference in productivity between the public and private sector nursing care facilities since there are few examples of operation by profit-making corporations. With respect to home nursing care, however, the results of estimates indicated that a 10.7% reduction in costs is attainable overall, since all providers achieved efficiency on par with profit-making corporations. Finally, productivity of day care centers was also measured using the same productivity function as used for medical care in which output is determined by multiplying the number of children using the facility by the number of hours of operation. The results indicated that the productivity of private day care centers is 21.1% higher than public day care centers.

Figure 2-4-2 Difference in productivity between public and private sector hospitals, home nursing care and day care centers

(2) Efforts relating to market tests and their status

Efforts relating to market tests

The Market Test is a scheme that has the public sector and the private sector compete on a level playing field and gives concrete form to the notion that what can be done in the private sector should be transferred to the private sector. As discussed in Section 2, the market test was introduced on a trial basis from FY2005 with respect to model projects of the central government. As full-scale introduction of the test approaches, plans have been set to establish a system that includes a legal framework ("Improvement of Pubic Service Efficiency Bill (or Market Testing Bill)" (provisional title).(47)

The following is a review of developments up to the introduction of the market test in FY2005. From October to November 2004, proposals for projects to be targeted for market tests were solicited from private businesses, etc., and 119 proposals were received from 75 business entities (Table 2-4-3). After considering the details of the proposals from private sector businesses by ministries, the concerned ministries issued a report concerning feasibility, giving the following breakdown: 18 responses were deemed candidates for model projects in FY2005; 13 responses were to be considered on candidates for market tests; 76 considered impossible or inappropriate as targets for market tests (of which 18 were duplications with other classifications). Meanwhile, for 46 of the responses, opening up to the private sector had already been completed (of which 18 were duplications), and 21 were factual errors (of which four were duplications). Negotiations between the Council for the Promotion of Regulatory Reform and the various ministries were held, and finally, in December 2004, eight projects to be the model projects for FY2005 were selected, which were related to three areas: "Hello Work"-related (public employment security offices), the Social Insurance Agency-related, and prison administration facilities-related. The specific projects targeted in each field were as follows: Projects related to Hello Work included employment support services such as free job placement services in career exchange plazas, employment support services in youth career exchange plazas, recruitment search services, and job training services in Ability Garden (centers for promoting lifetime employment skills development). Projects related to the Social Security Agency-related included collection of national insurance premiums, promotion of application of employees' pension and public servants' health insurance for establishments which do not apply to insurance, and operation of pension helpline. Projects related to prison administration facilities-related included assistance work for patrolling prison facilities and dealing with inmates. For these model projects, initiation procedures are steadily moving ahead, with many private sector businesses having already participated in biddings.

Table 2-4-3 Details of the selection of the model projects for "market testing"

The reasons why some of the proposals for model projects received from private sector businesses were deemed unsuitable for the market test by the concerned ministries are as follows. Reasons relating to the public nature of the project(48) included "associated with the use of public authority," "necessity for fairness or neutrality," and "need for administrative judgment." Many of the reasons given by the concerned ministries related to maintaining the confidentiality of information and protecting private information.(49) In addition, existing legal regulations stipulated that the specific operations given in proposals received from private businesses must be performed by the government.(50) Maintaining confidentiality and protecting private information are common issues that arise in implementing the shift from the public sector to the private sector, which means that it is necessary to consider schemes for ensuring that contractors fulfill the obligation to maintain confidentiality. Other regulatory issues also require further study.

2. Challenges Associated with Realizing an Effective Shift from Public Sector to Private Sector

As described above, moves toward a shift from the public sector to the private sector have, in recent years, been progressing at a rapid pace in many quarters, but the anticipated effect will not be realized merely by introducing systems. What is necessary for improving the efficiency of public finance and increasing the satisfaction of users is a variety of environmental adjustments.

(1) Review of government systems

In order to generate benefits from the shift from the public sector to the private sector, it is, first of all, necessary in the government sector to create an environment in which the experience and expertise of the private sector can be utilized to the maximum extent.(51)

Budgetary and accounting systems

When decisions to open up a public service to the private sector are made, it is necessary to acquire a quantitative understanding of the magnitude of costs which hitherto have been borne by the public sector and the degree to which these costs can be reduced through a transfer to the private sector. However, fiscal management by the public sector is mostly conducted on a cash basis, and it is difficult to calculate costs inclusive up to expenses of indirect sectors in order that separate accounting is not performed for each undertaking. Actually, there are many instances where comparisons with the costs of the private sector cannot be made assuming the same conditions. In order to ascertain objectively the disparity in costs between the public and private sector and open up the government market to the private sector effectively, it would be beneficial to refer to private sector accounting systems in the business sector.

In order to minimize costs throughout an entire life cycle of undertakings by opening up public services to the private sector, contracts for multiple fiscal years will be necessary. In such cases, budget execution is required over multiple fiscal years through allowing expenses funded by revenues in successive years. However, if the requirements for allowing budget execution over multiple fiscal years are too strict, the opening up of public services to the private sector will be restricted, or, conversely, if such budget practices were recognized in a disorderly way, damage would result from the loosening of fiscal discipline. Hence, a balance between the two is necessary. To achieve this balance, some degree of flexibility in allowing budget execution over multiple fiscal years is necessary. At the same time, strong emphasis must be placed on budget management not only for single fiscal years but also on budget management over multiple fiscal years, and it is also necessary to tighten the management of budget execution so that debt does not rise in subsequent fiscal years even for individual projects.

Moderating the factors behind regulatory impediments

As seen previously, the introduction of the Designated Management Entity System by amendment of the Local Autonomy Law has made it possible to entrust the management of public facilities of local government. However, in fields in which central and local government have been positioned as "managers" by other laws and ordinances, blanket entrustments remain difficult. In addition, there are restrictions on the disposal, by transfer or other means, of assets associated with public facilities acquired from the allocation of state subsidies. Such restrictions should be limited to fields in which government involvement is truly necessary, and it is important that the mode of government involvement also allows the private sector to exercise a certain degree of discretion.

However, moves toward a partial relaxation of these restrictions on the use and disposal of public facilities can also be seen. Specifically, the February 2004 decision to implement the Regional Revitalization Plan has led to a number of undertakings specified in Regional Revitalization Plans. These include the establishment of open cafs, more flexible exclusive-use road permits, easier acquisition to road use permits for movie locations, events and car races, and measures to increase flexibility in the use of public facilities by conversion to welfare and industrial use facilities such as school buildings established by subsidies.

Improving the accountability and transparency of government

When government intends to continue implementation of a project or undertaking, it must, on the basis of objective facts, demonstrate the appropriateness of the government itself continuing to implement the project. To fulfill this obligation of accountability, government must have the ability to perform objective policy assessments through statistical methods and other techniques. In addition, for instance, when opening up public services to the private sector, government must provide for the preparation of bidding terms, evaluations of the details of proposals from the private sector and appropriate monitoring of private sector service provision during the period of the undertaking. This requires the preparation of guidelines for carrying out such functions and the use of outside professionals for performing evaluations.

Dealing with the problem of government employment

The shift from the public sector to the private sector raises the issue of how deal with surplus government staff generated by the shift. This will require the establishment of systems that can flexibly reassign personnel to other posts within government from those areas in which government involvement is not necessary to those in which demand for government is increasing. At the same time, to accommodate personnel who wish to work for the private sector, an environment that can ensure the portability of pensions between government and the private sector and facilitate other adjustments must be created to ensure smooth transfers to the private sector.

(2) Establishing a competitive environment

In order to realize the anticipated benefits from the shift from the public sector to the private sector, it is decidedly important that private sector businesses that have regularly undertaken public services face potential competitive pressures. In this sense, if the potential competition with private sector businesses can be maintained, even where the government continues to implement the project on its own, significant benefits can be realized. Seen from this perspective, Japan has yet to witness a significant expansion of the competitive environment, judging from the various systems that have been introduced thus far.

Improvement of bidding procedures

To give specific data illustrating the current state of the competitive environment in Japan, a Ministry of Internal Affairs and Communications document (2004a) concerning methods of concluding entrustment contracts for typical projects of municipalities indicates that in many business fields, only about 10% to 20% of contracts are concluded through competitive bidding, with the majority being arbitrary contracts in which a specified counterparty is arbitrarily selected with no competition (optional contract). In addition, selection of managers under the Designated Management Entity System is also made by a majority of local governments without public invitation. These facts indicate that the opportunities for opening up to the private sector are not sufficient. Under these conditions, the principles of competition between businesses that have undertaken public services and other potential competitors function inadequately, raising concerns that over the long term there will be few incentives for improving further the quality and efficiency of service provision. In cases where the local government is small, the candidates of private sector businesses that would be suitable for entrustment are limited by geography, but this problem could be overcome by collective commissioning of projects through a broad alliance beyond the framework of municipality.

Equalizing the terms of competition and invoking market mechanisms

Another requirement in pursuing the shift from "public sector to private sector" is to establish a process whereby market mechanisms are invoked to ensure that businesses that provide high-quality services more efficiently are the ones that do provide the public services. In such cases, it is important to take steps to equalize the terms of competition between the public sector and the private sector. Under the current system, when the provision of a public service is transferred from the public sector to the private sector, subsidies toward that undertaking are, in some cases, not applicable. However, from the standpoint of equalizing the terms of competition between the public sector and the private sector, a neutral system design not dictated by the mode of provision or by the provider is required. For example, shifting from the provision of subsidies to the service provider to a voucher system that would provide direct aid to users would erase disparities created by other measures to support the provider. The voucher system could be termed a method that makes excellent use of market mechanisms in the sense that it expands the range of choices available to consumers.

Increasing the use of benchmarking

Benchmarking is also an effective technique for providing the incentive to adopt best practice methods of improving the efficiency of public service providers. For example, indexation of the costs and results of businesses and groups in specific undertakings would allow comparisons and heighten businesses and groups' awareness of competition. In other industrialized countries, particularly in the fields of education and medical care, indexes have also been developed concerning the quality and cost of public services, which helps to spur competition between public service providers.(52) In Japan, meanwhile, a local government hospital administration index has also been announced, which indicates administration indexes by type relating to hospitals with good administration practices. By comparing these indexes, the status of administration in the various hospitals can be ascertained with a view to improving management. Similar management indexes have also been announced for operations such as water and sewage works, and these indexes help to enhance accountability relating to the provision of public services by government.

3. Conclusion

The main points considered in this chapter are summarized below.

Achieving small government

Section 1 analyzed the relationship between the size of government and economic activity and the awareness of the public toward government size. Generally, the size of government is expressed either as the amount of spending and burden or as the strength of government involvement in terms of regulation. In either case, when government becomes large, the effective distribution of resources by the economy as a whole will not be achieved, and economic activity is likely to be less vigorous than it is under a smaller government. Estimates using OECD country data found that as the size of government spending becomes large, a negative effect is exerted on the economic growth rate, suggesting that there is a close relationship between the size of government spending and macro-economic activity. The results of the study also indicated that as the strength of regulation increases, productivity declines. In light of this evidence, certain checks must be imposed on the expansion of government size.

A questionnaire survey reviewed detected a trend for the public to prefer small government. The results of the survey were examined by conjoint analysis, which revealed that people will accept some degree of increase in the burden they shoulder in the case of spending that returns some direct benefit to them, as in the case of social security expenditures, but that there is not much acceptance of an increased burden when government spending brings no direct benefit. Therefore, it is important in order to obtain the support of the public, they be given an understanding of why a public service provided by government is necessary, and that controls over the size of government be appropriately exercised by thoroughly reviewing the content of expenditures and reducing their scale.(53)

Promoting the shift from the public sector to the private sector

Section 2 discussed the new division of roles between government and the private sector and examined the advantages and drawbacks of various methods for achieving the shift from "public sector to private sector." Because of changes in the economic and social environment, a review of the division of roles between government and the private sector is required even in fields originally the domain of government. This division of roles is effected through transfers of operations from "public sector to private sector" of blanket public services, and one sweeping method for promoting these transfers requires the full-scale introduction of market tests. The important advantages of shifting public services from "public sector to private sector" are not only the contribution to improving the efficiency of public finance, but also the improvement in the quality of public services provided through the use of the experience and expertise of the private sector under appropriate contractual relationships. It has been observed from the results of a survey concerning businesses that operate facilities established by government but managed by the private sector that, under the Designated Management Entity System, private sector businesses are superior to government in developing service provision systems. The survey also indicated that NPOs designated as designated management entities are also superior to government in building partnerships with residents.

The privatization of public corporations represents one form of shifting from "public sector to private sector," and past privatizations have demonstrated their great effect on improving profits and promoting the participation of private sector businesses. Judging from the harsh business environment in which Japan Post operates, increasing the discretion of management and the ability to sustain profitability independently through privatization are important for decreasing the risk of a larger future burden on people. By means of the fiscal reforms which have already been set firmly in place and the upcoming privatization of the postal service, it can be expected that the flow of funds which has leaned toward government will change and contribute to activating the private sector economy. Meanwhile, fund procurement by the public sector will stay thoroughly in line with the principle of procuring only the amount necessary from the market. Accordingly, policy-based finance must follow the principle that financing, in the final analysis, serves to complement the private sector and carefully select those projects that are truly necessary, giving thorough consideration to function.

From the state to the regions

Section 3 gave an overview of administrative and fiscal reforms in the regions. Considering the fact that many public services are performed at the regional level, to achieve small government, it is crucial not only to give local government, as the actual director of operations, a wide range of discretionary powers but also to promote administrative and fiscal reform. The reform of the fiscal relationship between the central and local governments is giving impetus to the streamlining of public finance encompassing central and local government and, by expanding the authority and responsibility of the regions, is increasing the independence of the regions. Meanwhile, in the municipalities that are the target of these reforms, systems are also being set in place through consolidation and various administrative and fiscal reforms. An analysis using data for municipalities nationwide confirmed that the advantages of economies of scale are becoming apparent through mergers and other measures for integrated management of larger regions by local government. Taking the overall view, improvements in the efficiency of public finance are proceeding for municipalities grappling with administrative and fiscal reform. Going forward, it will be important in terms of improving the efficiency of public finance to take lessons in best practice from those municipalities that are succeeding in improving administrative efficiency.

Achieving an effective shift from public sector to private sector

Section 4 considered the problem of achieving an effective shift from "public sector to private sector." Although various systems have been introduced to facilitate this shift, appropriate measures must be adopted for the use of systems in order to ensure the effectiveness of the shift. Specifically, in order to increase the participation of the private sector and promote competition between the public sector and the private sector, the process of bidding and selection of businesses must be performed with transparency and fairness. It is also necessary to lower the regulatory barriers that restrict the private sector as much as possible. Further, it is important for both the public sector and the private sector to deepen their understanding of systems and then use this understanding to acquire knowledge and skills. In order to promote the opening up of a wide range of government services to the private sector, moreover, it is necessary to consider mechanisms for protecting private and confidential information and measures for facilitating the movement of personnel between public and private sectors. Finally, it is necessary to create a process for providing efficient, high-quality public services through skillful use of market mechanisms and by promoting competition between the public sector and the private sector.

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