A Factor Analytic Assessment of Financial Sustainability: The Case of New South Wales Local Government

The financial sustainability of local government continues to be a cause of great concern for policy makers in Australia and abroad (Dollery et al. 2012). In an effort to monitor the financial problems which many municipalities face, policy makers are increasingly turning to financial ratio analysis (Drew and Dollery 2014). Yet simply monitoring the decline of municipal fortunes is, in itself, unlikely to improve matters. What policy makers and council officers need to know is why the financial sustainability of councils continues to deteriorate. One way of answering this question is to conduct multiple regression analysis to identify the determinants of the various financial ratios. However, this empirical approach has largely gone unrewarded owing inter alia to the need for 'a priori' specification of regressors and functional form. By way of contrast, factor analysis - a technique not commonly employed in the local government literature - offers a window into the latent factors responsible for the observed data, irrespective of whether they are currently able to be quantified. The incremental knowledge thus accrued can then assist public policy makers in their attempt to arrest the decline in municipal financial sustainability.