The strategy of budget system reform in emerging countries.

Author:Diamond, Jack


This paper examines the process of budget system reform implied by moving from traditional centralized input-oriented systems to more modern devolved performance-based systems. Based on the experience of recent attempts at this reform in emerging countries, the required sequencing of steps in this process is stressed. The strategy outlined involves a three-prong approach, requiring measures to increase the flexibility in the agency operating environment, provide more certain resourcing for spending agencies, and exert pressure on agencies to improve their performance. The paper stresses firstly, the need to progress on all three fronts simultaneously, and secondly, to base these reforms on a firm platform of agency management skills. The need to attain some basic public expenditure management thresholds in the area of restructuring the budget and its classification, improving the accounting system, developing a financial management information system, and strengthening internal financial management skills, is highlighted.

Stages in Budget System Development

Among the major challenges faced by emerging market economies has been the need to adjust institutions to function in an increasingly market-oriented and global environment. One of the most important of these institutional reforms has been the restructuring of their budget systems. (2) The latter should be interpreted quite widely to encompass the institutional framework as well as the administrative procedures that determine the means whereby resources are transferred to government, how the use of these resources is prioritized and directed to agreed policy objectives, and then subsequently managed, controlled, monitored, and reported on. It is generally agreed that a modern budget system should be able to meet three main requirements: first, to ensure control over expenditures so that they are consistent with the budget law; second, to stabilize the economy through timely and efficient adjustment in fiscal aggregates; and third, to promote efficiency in service delivery through procedures that provide incentives for greater productivity. (3) Typically, budget systems have evolved by progressively assuming, and placing different emphasis on, these three requirements. Traditionally, the most basic systems focus on the first objective--ensuring compliance with the annual budget law. Typically, this has been manifested in detailed line-item budgeting. While meeting basic compliance requirements, traditional budget systems usually then have been modified to accommodate the government broad stabilization objectives and its need to control fiscal aggregates. This usually involves incorporating a top-down approach to ensure that fiscal policy can be harmonized with monetary policy, introducing procedures so that the government has the means to plan, control, and monitor spending effectively and to be able to adjust fiscal aggregates to meet fiscal targets which are increasingly set in a multi-year framework. After budget systems are capable of handling compliance and stabilization objectives, typically increasing emphasis has been placed on the third objective, to ensure efficiency and effectiveness in the use of government resources. Putting in place mechanisms to ensure the latter has progressively become the focus of interest for OECD budget managers over the last two decades. The challenge has been to ensure enough flexibility for budget managers to be given ample scope to manage while not sacrificing compliance and overall macro stabilization objectives.

The move to this third phase has been spurred from two separate sources. First, the limitations of traditional compliance-oriented budget systems became more apparent. Second, with the increased use of more flexible budget management procedures, there was increased realization that stabilization and efficiency objectives were not necessarily competing, but could be complementary. Traditional budget systems, based on short-term and detailed control of inputs, have generally been discredited as a tool for promoting public sector performance, which by definition should focus on the outputs or the impacts resulting from these inputs (see Box A).

Box A. Pros and Cons of Traditional Line Item Budgets Cons: * Budget divided by spending unit/activity centers which may have several programs * Prepared annually, with year-end rush to spend * With typical incremental approach favoring existing programs, regardless of priority * Based on line items of expenditure, control is on inputs rather than outputs or impacts * Reports are for compliance purposes, by institution and approved cost, usually detailed * Reports for stabilization purposes, and control over aggregates need additional economic classification * Supporting accounting system is cash based, focused on payment stage of spending process only Pros: * Usually provides compliance control, allowing payments to be limited to voted appropriations * Provides database for across-the-board cuts to control fiscal aggregates * An uncomplicated system, easy to understand, focused on "the bottom line" * Easy to apply in a tight timetable, annual, minimizes discussion on programs/objectives * Adaptable to different economic situations (being incremental as well as decrimental) * Reporting is not demanding, accounts prepared after year-end, for statutory review and audit * Cash basis accounting is relatively easier to implement and maintain The increased suspicion that fiscal stabilization objectives were being achieved at the cost of performance, led to OECD countries modifying their budgets into performance management instruments and not just instruments of macro control. When introducing performance management in their budget systems, with associated increased managerial freedom, it became evident that greater managerial flexibility could be viewed not only as a tool to improve efficiency but also to achieve the expenditure targets that had been set. Typically, managers of individual programs are in the best position to decide on the most appropriate mix of inputs to be used for executing their programs. By providing them greater managerial freedom managers could be assisted in achieving tighter budgetary limits--that is, improved efficiency in resource use could support stabilization targets. (4)

Most emerging countries (5) are only now entering this final stage of budget system development and, in attempting to move to this next stage, find themselves facing common problems. Their past attempts to ensure that budgetary processes would deliver a satisfactory aggregate fiscal outcome in support of macroeconomic stabilization, revealed certain limitations. Even when care was taken to incorporate some degree of budget flexibility, typically the budget systems were left with a complex set of restrictions. These were increasingly recognized as diminishing the allocative and operational efficiency of budget execution, typically with budget managers' operating with limited responsibility for results. Accordingly, there has been growing acceptance that the next stage of reform is to provide greater inducement for managers to focus on possible improvements in allocative and operational efficiency at the program delivery level.

The Elements of the Reform Agenda

International trends in budget reform, directed at improving the trade-off between tight fiscal control and effective program execution, can be characterized as involving an interdependent three-track reform agenda:

* Provision of increased flexibility to spending agencies in their access to budget funds and the uses to which funds can be put.

This concern with increased flexibility has focused mainly on the ability of spending agencies to reallocate funds within controls on budget line items. Changes are directed at giving organizations and managers greater freedom in operational decisions and removing unnecessary constraints in resource management. In return, organizations and managers are more directly accountable for results. Australia, New Zealand, and the Nordic countries have led reforms in this direction, and Canada and the United Kingdom reflect the same approach. There are still a number of OECD countries that resist giving increased powers to public servants and are suspicious that overspending will result if they do. Thus the United States continues to exert firm congressional control over the executive branch, (6) and France, while freeing controls on operating expenditures, still exerts central control over staffing.

Reduction of line item specificity in the budget has been a general feature of such reforms, although, in different countries, increased flexibility has been provided in different ways. A first step is usually the consolidation of detailed appropriation items into wider-banded expenditure categories. The portfolio budgeting approach giving ministries greater flexibility and incentive to reallocate resources within portfolio allocations to reflect changing priorities, is a more pronounced form of this approach. A minority of countries has also introduced greater end-of-year flexibility by allowing a carryover of unused appropriations, and the use of net appropriations to encourage the generation of nontax revenues to finance specific types of spending. However, the latter approaches and resource agreements, as in the Australian and New Zealand systems, allowing the sale or acquisition of fixed assets, are still regarded as radical by most countries. All such approaches are founded on two main preconditions: a tight budget constraint which agencies observe; and adequate capacity in the Budget Office (BO) to monitor developments and intervene if necessary.

* Provision of greater certainty in the operating environment of spending agencies, particularly in regard to availability of funds.

There is usually the need to take parallel steps to increase the certainty of budget...

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