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November 26, 2007

PFM Reforms and Public Expenditure Efficiency: Key PFM Reforms Playing a Role in Effectively Controlling Public Expenditure

Posted by Michel Lazare

There are seven key institutional arrangements for budgeting that play a key role in effectively controlling public expenditures in OECD countries.

This is at least the view presented in 2005 by Jon Blondal (the then Acting Head of the Budgeting and Management Division of the OECD) on the occasion of the 7th Banca d'Italia Workshop on Public Finance. In Jon Blöndal's view, there are three major determinants of the fiscal outcomes of OECD member countries: (1) the general performance of the economy (which is the main driver), (2) the political commitment to fiscal discipline, and (3) the institutional arrangements for budgeting. The presence of the two first factors being insufficient to experience a successful fiscal outcome.

The seven key institutional arrangements for budgeting that play a key role in effectively controlling public expenditures in OECD countries are the following:

  1. Medium-term expenditure frameworks: by clearly stating the government's medium-term fiscal objectives in terms of high-level targets they "form the basis for achieving fiscal consolidation;"
  2. Prudent fiscal assumptions: "deviations from the forecast of the key economic assumptions underlying the budget are the government's key fiscal risk;" hence the need for prudent and fully disclosed economic assumptions;
  3. Top-down budgeting techniques: "the starting point for this new budgeting approach is for the government to make a binding political decision as to the level of expenditures and to divide them among individual spending ministries; this decision is made possible by the medium-term expenditure frameworks;"
  4. Relaxing central input controls: "this is based on the simple premise that the heads of individual agencies are in the best position to choose the most efficient mix of inputs to carry out the agency's activities; the end result is that an agency can produce the same services at less cost;"
  5. Focus on results: results-oriented budgeting "is a direct quid pro quo for relaxing input controls;" "managers are then held accountable for what they do and not how they do it;"
  6. Budget transparency: transparency helps getting the public's understanding of the need for fiscal discipline; and
  7. Modern financial management practice: this seventh area covers in fact several practices:
    • Accruals:  this covers accrual financial statements and budgeting;
    • Capital charges: a mechanism to track and charge agencies for the cost of capital is expected to foster efficiency in minimizing the amount of capital used;
    • Carry-overs: instituting carry-overs aims at avoiding an "irrational rush to spend money before the end of the fiscal year;" and
    • Interest-bearing accounts: letting agencies receive an interest income when they spend at a measured pace is expected to provide an incentive to improve their cash management practices.

PFM Blog's assessment: Jon Blöndal's presentation provides stimulating thoughts about the role that budgeting arrangements can play in achieving successful budget consolidation and improving management of public money. Even if there is no causality between these arrangements and successful fiscal outcome, there might indeed be some correlation in OECD countries.

These views should nevertheless be taken with some caution and they certainly do not constitute a list of "to-dos" for successful fiscal management:

  • First, the list of measures is a bit of a mixed bag. Some are quite important (MTEFs, result-oriented budgeting), others are more marginal budget execution techniques (e.g., interest bearing accounts--which by the way is a technique difficult to apply in a centralized budget execution environment like the Francophone countries);
  • Second, the list of measures may not be fully comprehensive. For instance, internal control would seem to be quite an important institutional arrangement for successful public management in OECD countries.
  • Third, as underlined by Jon Blöndal, this approach is OECD specific. Some of these measures are pretty sophisticated and their introduction in more rustic budget management systems would certainly prove (overly?) challenging (even in OECD countries, their introduction has been actually often challenging) and may not produce expected results.

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