PUBLIC CAPITAL BUDGETING AND MANAGEMENT: THE CONCEPT AND ITS APPLICATION IN THREE IMPORTANT FEDERATIONS.

Author:Ermasova, Natalia
 
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  1. INTRODUCTION

    Public infrastructure is critical for economic growth and development and for comfortable life. This infrastructure contributes directly to the production of desirable government outcomes (like facilities used in public education or hospitals), as well as serves as an input to production of goods and services by private entities (like harbors and waterways). At its best, the capital budget process provides a means for evaluation, choice, management, renewal, and development of core public physical assets. When it functions properly, the process contributes to the common good. When it malfunctions, the public can be endangered by an infrastructure that does not meet the standards for delivery of safe, convenient, and efficient service to the public.

    Underinvestment in public assets has proven to be a problem in many nations, including the three federations examined in detail here. The problem is considerable in the United States (Chen, 2014, 2016, 2017; Chen and Bartle, 2017; Ermasova, 2013; Ermasova and Ebdon, 2019; Srithongrung, Ermasova, and Yusuf, 2019). Chen (2018) found that "declining quality and poor performance of public infrastructure system impose huge costs on US businesses and individuals and create bottlenecks that constrain economic development" (p.126).

    Germany faces similar issues. Due to decreasing capital investments, Germany fell from third on a list of countries with the best infrastructure in 2008 to seventh place in 2013 and tenth place in 2017 (German Council of Economic Experts, 2018; German Finance Ministry, 2014, 2015, 2018; Ermasova, 2019, Van der Putten, 2017).

    These problems are also particularly significant in the Russian Federation. In Russia current levels of investment funding are far below what is needed to properly maintain, improve, and expand public infrastructure to avoid economic costs and inefficiencies (Ermasova, 2019). WEF Global Competitiveness Report (2018) shows that the lack of capital investments over the last 20 years has dropped Russia to 35rd place globally in quality of overall infrastructure. Because there has been mounting disquiet about the status of public infrastructure in the United States, Germany and Russia, it is particularly appropriate to reassess their capital budgeting, asset acquisition and management systems so that these resources may serve their appropriate functions.

    Four sections follow. The first section examines the thoughts and theories about capital budgeting that have developed over roughly the past half century. In light of the significance of capital infrastructure, it is no surprise that there are many views on the topic, not all consistent with each other. The second section considers the practice of public capital budgeting by comparing capital budgeting across three important federations--the Federal Republic of Germany, the Russian Federation, and the United States--to provide a sense of how ideas are implemented in countries with apparent organizational similarities but with great differences in practice. The third section considers the problem of asset underinvestment and approaches that have been developed to attempt to remedy the problem. The final section identifies important gaps in academic and practical understanding of capital asset investment and management and how the capital budgeting process might be revised to improve the condition of society. The article provides a greater understanding of capital budgeting in different countries and identify avenues for fruitful future research.

  2. LITERATURE REVIEW

    Capital budgeting, in common with budgeting overall, is partly political, partly economic, partly accounting, and partly administrative (Hyde, 2002, p.1). As a political process, capital budgeting allocates the scarce resources among different government departments, agencies, and investment projects. Because capital projects are place-specific, political debates can become particularly intense. As an economic and fiscal process, capital budgeting serves as the primary instrument for evaluating needs for capital improvement, analyzing the condition of infrastructure, and assuring that the program can be financed. As an accounting process, it tracks government spending on capital projects. The process itself is the part of the fiscal management system focused on capital assets. (2) Finally, as a managerial and administrative process, capital budgeting establishes criteria by which public services are monitored, measured, and evaluated (Khan and Hildreth, 2002).

    Many scholars (Ammar, Duncombe, and Wright, 2001; Boex, Martinez-Vazquez, and McNab, 2000; Chen, 2017; Chen and Bartle, 2017; Bland, 2007; Beckett-Camarata, 2003; Ermasova, 2012, 2013; Ermasova and Ebdon, 2019; Halachmi and Sekwat, 1997; Kovner and Lusk, 2010; Mikesell, 2007; O'Toole and Stipak, 1988; Srithongrung, 2008, 2018; Srithongrung, Ermasova, and Yusuf, 2019) have explored whether strategic practices can be integrated into capital processes. Premchand (2006, p.29) agreed with the importance of the multi-year budget framework and highlighted the necessity of following changes in expenditure management: (1) preparation of a medium-term fiscal outlook; (2) preparation of medium term rolling expenditure budgets; (3) formulation of functional or program resource ceilings; (4) recognition of risks and associated measures; (5) formulation of priorities and strategies; (6) explicit recognition of performance links; (7) fundamental or periodic reviews; and (8) introduction of accrual budgeting and accounting.

    A large number of studies analyze how capital spending decisions have been made (e.g., Temple, 1994; Balsdon, Bruner, and Rueben, 2003; Chudhury, Clingermayer, and Dasse, 2003; Srithongrung, Ermasova, and Yusuf, 2019). Poterba (1995); Gordon, Kleiner, and Natarajan (1986), Srithongrung (2008), Srithongrung, Ermasova, and Yusuf (2019) focused on the impacts of administrative institutions, including the use of a separate capital budget. Halachmi and Sekwat (1997) found that the use of separate capital budgets leads to strategic practices, including capital planning and infrastructure inspection, in local governments. In contradiction, Spackman (2001, p.34) pointed out that capital and current budgets should be considered together:

    "(1) budgeting and decision-making processes for capital and current spending must be considered together; (2) capital spending within the budget, once it is set, must be clearly identified separately; (3) investment proposals should be subject to processes for appraisal (of the capital and all the associated operating costs); (4) strong procedures should be in place for capital asset procurement and for project management, and for subsequent monitoring and management of capital assets." Dorotinsky (2008) argued that "the well-designed public financial management system supports each aspect of the system, including capital spending. In summary, an effective capital budgeting process should form an integral component of a sound over-all budgeting system" (p.20). Many authors find that public capital management practices enhance the quality and quantity of public infrastructure systems (Ermasova, 2012, 2013, 2019; Kovner and Lusk, 2010; Orszag, 2008; Srithongrung and Kriz, 2012; Srithongrung, 2010, 2018; Srithongrung, Ermasova, and Yusuf, 2019).

    The government institutions play a crucial role in determining the scope of government capital spending. Questions such as "Is the fluctuation in spending considered optimal or an under-investment, relative to the public needs?" and "What should be an objective guide for public investment?" are of particular concern. However, some models focus on factors other than budget procedures in assessing public infrastructure choices. The alternatives include the bureaucracy model (Berry and Lowery, 1987, Courant, Gramlich, and Rubinfield, 1979; Niskanen (1971), the fiscal illusion model (Buchanan and Wagner, 1977; Dollery and Worthington, 1996; Rogers and Rogers, 1995), public policy literature (Gramlich, 1994) and political economy literature (Glazer, 1989, 1993; Crain and Oakley, 1995). According to the bureaucracy model, bureaucratic self-interest is the main cause of public sector expansion beyond the optimal level (Berry and Lowery, 1987). Niskanen (1971) suggests that bureaucrats are likely to expand the government budget and to control information in their relationships with legislators. According to fiscal illusion theory, government revenues are not completely transparent and the true costs of government may be consistently misconstrued by the citizenry of a given fiscal jurisdiction (Buchanan and Wagner,1977; Dollery and Worthington, 1996; Rogers and Rogers, 1995).

    Liu and Mikesell (2014) highlight that "politicians, as vote maximizers, tend to propose new government programs as much as possible to attract new voters, which makes government bigger" (p.348). The political economy literature on pork barrel politics suggested that capital projects are allocated to politically powerful legislators or based on election considerations, rather than on productivity criterion. Glazer (1989) wrote, "the rational voters will show a consistent bias in favor of building durable projects" (p.1207) and it depends on commitment effect and efficiency effect. Glazer (1993) suggested that a fundamental aspect of collective decision-making in choosing capital projects should be recognized. Glazer (1989) highlighted that durable project "forces government to provide some services that voters in the future may prefer it did not" (p.1212). Liu and Mikesell (2014) analyzed the impact of public officials' corruption on state spending and found that "show that real per capita state construction expenditures tend to be larger in states with higher levels of corruption, and the impact is statistically significant. This finding is consistent with the view that corrupt public officials...

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