Angels and Demons – the Political Economy of PFM Reform
In a thought-provoking presentation during the IMF Fiscal Affairs Department’s (FAD) 50th Anniversary Conference on December 5, 2014, Professor Ravi Kanbur of Cornell University analyzed the intellectual origins and roots of FAD. In his view, these roots derive not from the influence of Keynes, one of the founding fathers of the IMF, who was more concerned with issues of monetary policy and balance of payments stabilization than with fiscal policy. A much stronger influence on FAD’s development was one of Keynes’ illustrious colleagues at Cambridge University, Arthur Pigou. Professor Kanbur’s main thesis [Presentation_Available here (.ppt)], however, was that FAD, while responsible for many important applications of fiscal policy, had taken little advantage of important recent work on political economy analysis, and the application of behavioral economics to fiscal issues. These developments derive from the work of notable economists such as Knut Wicksell and 2002 Nobel Prize winner Daniel Kahneman. Another strong influence has been the work on public choice theory and the economics of state bureaucracy, a line running from Pareto, through the great Italian school of public finance to the work of scholars such as Buchanan, Tullock and Peacock.
Does this evolution of thinking from Pigou to Wicksell and Kahneman have implications for FAD’s work on public financial management? The short answer is “yes, a great deal”. For example, the lack of attention to political economy factors and behavioral economics may help explain why, over the past 10-15 years, many reforms in developing countries and emerging market economies have failed to progress. Some appear to have hit an “institutional wall” beyond which further progress has proved impossible.
Such failures may include the development of financial management information systems (FMIS), treasury single accounts (TSAs), and improvements in accounting and financial control systems. The evidence presented in a recent World Bank study, for example, is sobering.2 The average completion time for 55 FMIS projects around the world was nearly 8 years, twice the original forecast. Many FMIS projects are not completed or have been reconstituted into new projects with a very similar mandate. One developing country (Ecuador) has worked on three separate but similar FMIS projects spanning a period of over 23 years.
By contrast, the modernization of revenue collection authorities in many developing countries, while not lacking challenges, appears to be less affected by “institutional walls”. A plausible explanation is that the development of such agencies, by broadening the tax base and improving the efficiency of revenue collection, provides such strong political support for reform that bureaucratic inertia and rent-seeking behavior are overridden. Revenue collection agencies are also much more focused organizations with fewer counterparts in the public administration. Thus, an alignment of incentives and priorities is easier to achieve on the revenue side but presents many challenges on the spending side of the budget.
What are the implications of Professor Kanbur’s argument for the work carried out by FAD and others on PFM reform? Vito Tanzi, a former FAD Director, and another distinguished presenter at the Anniversary Conference reminded the audience that in the early days of the Department, the accepted approach in FAD was to limit the scope of advice given to national governments to the technical aspects of PFM (or other fiscal policy issues) leaving it entirely to the government to work out how these technical solutions should be designed and implemented in the country context. This culture has survived for many years and, of course, is the antithesis of the political economy approach. I would venture that it has not led to satisfactory results and, if Professor Kanbur’s analysis is correct, some rethinking needs to be done.
First, the “institutional wall” hypothesis set out above should be tested empirically. How strong is the evidence that “institutional walls” exist for some types of PFM project, but not for others? A related question is whether there is any evidence that conditions attached to IMF (or World Bank) programs affect the probability of PFM reform success. The IMF and World Bank have been providing advice on TSA, FMIS and other major PFM reforms for many years. A wealth of data has been gathered about the success or failure of these projects which could be used in undertaking the required research.
Second, analysis of political economy and behavioral issues should be incorporated in the diagnostic tools used to assess the strengths and weaknesses of PFM systems. Analytical work in these areas would require new skills and expertise, in political science and behavioral economics in particular. This is not a new idea. In her keynote speech at the ODI’s CAPE Conference in November 2013,3 Antoinette Sayeh, Director of the IMF’s African Department and former finance minister of Liberia said that “the IMF and the donor community should not only be observers and analysts of the political economy in a country, but a reasoned voice in the process. [They ….] should engage in dialog with ministers, parliamentarians and civil society to explain the implications of weak practices and present realistic solutions to address them.” Ms. Sayeh also noted the importance of the IMF maintaining a stronger presence on the ground in countries in order to participate in the debate on institutional reforms.
Third, the incentives of the various parties engaged in PFM reform should be assessed. While there are of course many contrary examples, it often seems in PFM reform that incentive structures in many countries encourage: (i) donors to be more concerned with the disbursement of funds for TA projects than with their impact and outcome; (ii) country stakeholders to be more concerned with maintaining rent-seeking opportunities than with genuine reform, while wishing to protect their ongoing relationship with the donors and IFIs; (iii) finance ministry’s to be more concerned with eye-catching projects that attract international attention than with giving priority to basic problems in the accounting and control of the budget; (iv) consultants to check off one more project with little concern for its impact and move on to another country; and (v) civil servants, supported by the trade unions, to be skeptical of all projects that upset their daily routine and almost reflexively obstruct the passage of new reforms.
How can all these negative incentives be transformed into positive ones, “bad guys” turned into “good guys”, and PFM reform demons transformed into angels? What kind of reforms are necessary in countries to change behavior and eliminate (or mitigate) “institutional walls”? Examples include infusing new blood in the ranks of senior finance officials to ensure their full support and leadership for the radical reforms that are required; building a broad consensus for reform among politicians, officials and taxpayers/voters; improving fiscal transparency and strengthening the role of the external oversight bodies; improving the organization of the finance ministry to shift responsibility down the management chain, mergeing departments and units, and reducing the power of organizational silos; strengthening the decision-making powers of the center of government (in particular the cabinet) to ensure that decisions on fiscal rules, spending ceilings, etc. are binding; and reforming the civil service to encourage greater job mobility and recruitment and promotion procedures based on merit rather than patronage.
Unfortunately, institutional reforms of this magnitude usually depend on high-level political leadership that may only be possible in countries emerging from extreme political or constitutional change, or economic and financial crisis. In such situations some countries have managed to achieve striking improvements in their budgetary institutions. Examples include New Zealand in the 1980s, Sweden in the 1990s, Chile, post-Apartheid South Africa, Kenya post-2011, Uganda under President Museveni in the 1980s and early 1990s, and some Central and Eastern European countries motivated by the desire to become full members of the EU.
Reforms such as these, however, are much harder to undertake in countries where the political and institutional environment for change is less favorable. Nevertheless, it may still be possible to make useful changes in behavior at the margin by developing the “soft” aspects of budgetary reform. Authors such as Matt Andrews have written wisely on this topic, arguing for example that reforms should focus initially on the most urgent PFM problems facing countries (e.g., expenditure arrears, absence of bank reconciliation, poor revenue forecasts) rather than grand reform strategies based on advanced country practices. Effective TA delivery should involve widespread consultation among interested parties in order to break down resistance to reform and, to the extent possible, seek to adapt existing practices rather than making huge leaps into the unknown.4 There may be other ways in which the behavior of officials can be motivated to produce better results. For example, officials who volunteer to pilot new PFM projects could be offered bonus payments or free access to computers, iPads and social media outlets, opportunities to work directly with ministers and top managers, and publications and news articles in which their names features prominently.
Unfortunately, change management approaches have not yet been widely incorporated in the PFM reform action plans of most developing countries. In contrast, most advanced countries have given considerable weight to these critically important “soft” dimensions of reform. This may partly explain the relatively steady progress of PFM reform in advanced economies.
1The author is an economist and a consultant with the IMF in Washington DC, as well as a Senior Research Associate of the Overseas Development Institute. He is the co-editor of the IMF’s PFM Blog and of The International Handbook of Public Financial Management, published in 2013 by Palgrave Macmillan.
2World Bank, 2011, Financial Management Information Systems: 25 Years of World Bank Experience on What Works and What Doesn’t. Washington DC: World Bank.
4Matt Andrews. 2013. The Limits of Institutional Reform in Development: Changing Rules for Realistic Solutions. Cambridge: Cambridge University Press. Andrews labels his proposed approach “problem driven, iterative and adaptive” (PDIA).
Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.