Fiscal Rules and Councils: Most Effective When Used Together

Posted by Elif C. Arbatli [1]

Adopting numerical fiscal rules has been an integral part of the policy response to the medium-term fiscal consolidation challenge posed by the global financial crisis. According to Schaechter et. al. (2012), since 2009, at least 16 countries have adopted new national fiscal rules and many others are in the pipeline. The crisis has also revealed the need for reforming supranational rules, such as the Stability and Growth Pact of the EU and as a result new structural budget balance rules will be adopted in almost all of the EU member states as part of the “fiscal compact.” A recent paper by Charles Wyplosz titled “Fiscal Rules: Theoretical Issues and Historical Experiences,” is a timely review of the theoretical underpinnings of fiscal indiscipline and how numerical fiscal rules can help. Wyplosz argues that fiscal rules are neither necessary nor sufficient to achieve fiscal discipline; but that thoughtfully designed fiscal rules can be effective when supplemented with fiscal institutions (and in particular fiscal councils) that are tailored to the political institutions of the country.[2]

The paper first looks at the theoretical underpinnings of fiscal indiscipline, known as the “common pool problem”. The common pool problem arises when the beneficiaries of public spending or tax policies do not take into account the externalities that these policies impose on other groups (within a population, across different generations, among different levels of government or different states within a monetary union). Fiscal rules can in principle reduce these externalities by imposing explicit principles for fiscal behavior and thereby lowering the scope for deficit bias. According to Wyplosz, there are two key challenges: 1) fiscal rules cannot be fully contingent and hence they are subject to the “time-inconsistency problem” and 2) fiscal rules cannot be fully binding since they can be manipulated, changed or simply ignored. He argues that fiscal institutions (in particular, fiscal councils or other arrangements that give authority to an independent body to interpret rules) can help overcome these challenges.

Going Broke? Why Pension Reforms Are Needed in Emerging Economies?

Previously published in iMFdirect (The International Monetary Fund's global economy forum), by Mauricio Soto

We’re all getting older, and there’s no doubt that pension reform is a hot topic in the advanced economies. But it’s also critical in emerging economies.

Our analysis here at the IMF shows that across emerging economies pension spending is projected to rise as the population ages. On average, these spending increases are not that large. But reforms are needed to increase coverage of the system without making pension systems financially unsustainable over the long term.

 

The Political Economy of Budget Reforms in Aid-Dependent Countries: Domestic and External Factors Shaping Success

Posted by Paolo de Renzio, Senior Research Fellow, International Budget Partnership and Research Associate, Global Economic Governance Programme, University of Oxford

The quality of governance and institutions is increasingly seen as a fundamental factor in shaping the development prospects of poor countries. As a consequence, donor agencies have increasingly allocated resources to providing support for improving governance standards in such countries. Their interventions are based on the assumption that, through a combination of financial and technical assistance, they can provide better incentives for reform and affect the quality of institutions in positive ways. Despite this existing consensus, research on how institutions develop and change over time is still incipient, especially in developing countries. Research on how donors’ influence affects governance trajectories and processes of institutional change in aid-dependent countries is even more scarce.

A paper recently published by the Global Economic Governance Programme at the University of Oxford investigates the domestic and external factors affecting the outcomes of reforms aimed at improving the quality of government budget institutions across a group of 16 aid-dependent countries. Government budgets are a key area of government action, through which policy objectives are chosen and acted upon, and the necessary resources are collected, allocated and spent. They have also become a crucial area being promoted by donors, backed by an increase in funding for technical assistance from US$ 170 million in 1997 to US$ 1.6 billion in 2007), covering a range of initiatives aimed at strengthening the rules and procedures which underpin budget processes. How has such external assistance worked? Were donors able to ‘buy’ better governance? What other factors shaped the outcomes of budget reforms? These are the key questions that the paper seeks to answer.

An Interview with Vito Tanzi

 
 

Posted by Carla Sateriale

Vito Tanzi was director of the IMF Fiscal Affairs Department for 20 years, from 1981 to 2000. Since then he has served as Senior Associate at the Carnegie Endowment for International Peace, Undersecretary for Economy and Finance in the Italian government, and consultant and scholar to various international institutions and research institutes. Since his retirement from the Fund he has authored 11 books. Last week Mr. Tanzi’s latest book, Government versus Markets: The Changing Economic Role of the State, was presented at IMF headquarters in Washington. FAD research assistant Carla Sateriale interviewed Mr. Tanzi on his new publication.      

 

What inspired you to write this new book, Government versus Markets, at this point in your career?

I’ve had at least three, maybe four careers throughout my life, which have shaped my perspective. I started in academia—studying at Harvard, and then teaching at American University and George Washington University. I spent 27 years at the Fund, then two years as a minister in the Italian government, and then several more years as a researcher and scholar at the Carnegie Endowment and at the Inter-American Development Bank. Finally, I decided to do what I had always wanted—have a period of my life with no formal commitments. I wanted to allocate all my time to reading, research, and writing. In many ways it has been the most productive period of my life. I have been able to publish five books between last year and now. Two of them in particular, The Charm of Latin America and Russian Bears and Somali Sharks, allowed me to weave together my perspectives on economics with my concrete experiences. Government Versus Markets gave me the opportunity to combine my observations on fiscal policy and regulation with my interest in the historical evolution of the role of the state.

Ireland Publishes Independent Review of Its Finance Ministry

Posted by Richard Hughes

 
In the lacuna between the general election in late February and the formulation of the new government earlier this month, Ireland’s Department of Finance (DoF) published the conclusions of an independent review of its performance over the decade leading up to and including the global economic crisis. The review was conducted by three person panel chaired by Rob Wright, former Deputy Ministry of Finance in Canada. 

While the report, entitled Strengthening the Capacity of the Department of Finance, complimented the DoF’s management of crisis itself, its account of the DoF’s performance in the run-up serves as a timely reminder of challenges that all finance ministries face in trying to chart a prudent course through the good times. Looking at the DoF’s advice to its ministers, the Cabinet, and Parliament (the Dáil) over the last ten years, the report found that the DoF did provide early and clear warnings about the pro-cyclicality of fiscal policy in Ireland. However, these admonishments went largely unheeded and, from the late 1990s onward, the fiscal stance of the final budget approved by Cabinet in November and the Dáil in December were consistently looser that that recommended by the DoF in June.

Le compte unique du Trésor : une idée révolutionnaire…en 1806!

Billet de Franck Bessette        

 
Si le concept de Trésor public a vu le jour en France au XIII^ème siècle, en ce sens que les fonds publics ont été séparés de la caisse personnelle du roi, la monarchie française a continué à recourir à des comptes distincts pour divers usages. Le concept du Compte unique du Trésor (CUT) a été le produit des difficultés qu’ont éprouvées pendant de longues années les divers gouvernements révolutionnaires qui se sont succédé après 1789 pour satisfaire leurs besoins de liquidités. Pendant l’essentiel de la période révolutionnaire, ce sont des banquiers privés («faiseurs de services»), dont certains se chargeaient de collecter les impôts, qui avançaient à l’État les liquidités nécessaires, mais à un coût très élevé. L’institution du Compte unique du Trésor a été l’aboutissement d’un long processus qui s’est accompli pour l’essentiel au cours de la première moitié du XIX^ème siècle. Il serait difficile de faire ici l’historique détaillé des réformes du système du Trésor en France au cours de cette période, mais on peut distinguer trois grandes étapes.

Treasury Single Account: A Revolutionary Idea…in 1806!

Posted by Franck Bessette        

 
While the concept of a State Treasury (le Trésor in French) was created in France in the XIIIth century in the sense that public monies were at that time separated from the king’s personal cash-box, the French monarchy still used separate bank accounts for various purposes. The concept of the Treasury Single Account (TSA) in France was the result of the long struggle of the various revolutionary governments after 1789 to meet their cash needs. During most of the revolutionary period, private bankers, some of them in charge of collecting taxes, were providing central government with the necessary cash but at a very high cost. The creation of a TSA in France was a gradual process, mostly accomplished during the first half of the XIXth century. It would be difficult here to give a detailed account of the reforms of the Treasury system in France during this period but this post would like to briefly underline the three major steps of this process.

Sound Public Financial Management Systems are a Key Element to the Successful Fiscal Decentralization Process

Posted by Mario Pessoa

Arguments in favor of decentralization range from devolving political decision making to the periphery to improving the provision of public services. However, the availability or lack of technical, human and financial resources and implementation quality seem to be critical to the success of the process. Even in places in which decentralization fails, the tendency is to continue implementation of the process because decentralization is often considered as one of the most important elements of a democratic system. So, the question raised is how to be more efficient in the decentralization process in order to prevent repetition of past failures.

Obama's plans for budget reform

Posted by Eivind Tandberg

On of the challenges facing the incoming US administration is how to contain and reduce the expected high and increasing budget deficits. A Washington Post article on January 7 quotes President-elect Obama as saying that:

Even if the package of spending and tax cuts helps restore the nation's immediate economic health,  the government is likely to be left with "trillion-dollar deficits for years to come" unless policymakers "make a change in the way that Washington does business."

"We're going to have to stop talking about budget reform. We're going to have to totally embrace it. It's an absolute necessity."

Whereas the challenges are clearly recognized, and the new administration has signaled a clear commitment to pursuing fiscal responsibility and sustainability, including through budget reforms, there has been little information on the specific mechanisms that may be applied so far. Much of the debate has on long-term fiscal issues has focused on taxes and on major expenditure policy issues, in particular related to social security and health spending. It will be interesting to see whether the new administration's proposals also will include concrete steps related to budget management systems and procedures.

The $800 billion stimulus package includes some provisions to enhance transparency and promote efficient use of the funds. These include establishing a special panel to monitor use of the money; a Web site that will allow taxpayers to monitor use of the money; and a ban on lawmakers' pet projects, known as earmarks. Perhaps we may expect that some of these mechanisms will be generalized or expanded to cover broader budget areas?

The Washington Post referred to an economic adviser saying that the president-elect plans to unveil "major initiatives" designed to eventually bring the deficit under control as part of his first budget proposal, which he will submit to Congress next month.

In the mean time, Congress members have began developing their own proposals. According to Examiner.com:

• Senate Budget Committee Chairman Kent Conrad and the Budget Committee's top Republican,  Senator Judd Gregg, have proposed a bipartisan fiscal task force of lawmakers and administration officials that would create a plan to reduce budget deficits and lower the national debt.

• Blue Dog Democrats would like to see legislation that would force Congress to pay for spending proposals with equal spending cuts or with new revenue.

• House Democrats this week plan to consider legislation that would require all federal agencies to undergo new audits and would call for congressional hearings when agency inspectors general find evidence of waste or fraud.

 

"Public Sector Reform in Sub-Saharan Africa: What can be Learnt from the Civil Service Performance Improvement Programme in Ghana?"

Posted by Lubin Doe

The October 2008 issue of Public Administration and Development (Volume 28 Issue 4 , pages 253 - 325) published an article by Antwi, K. B. , Analoui, F., and Nana-Agyekum D. entitled "Public Sector Reform in Sub-Saharan Africa: What can be learnt from the Civil Service Performance Improvement Programme in Ghana?"

The authors structured their work in three parts: the role of the government, public sector management challenges and civil service reform in Ghana

Role of government. The debate is presented as a choice between two theories: public interest and public choice. The public interest theory considers the law of supply and demand as unable to yield sustainable real economic growth, high social welfare and optimal equity. Therefore, government intervention is necessary to eliminate/reduce the effects of market failure. The public choice paradigm attributes public sector failures to the inability of governments to deliver quality public goods and services efficiently and transparently because of rent-seekers.

Strengthening Political Economy Analysis to Address the Resource Curse

Posted by Teresa Dabán

photo by Ellie Sandercock (CC)

The chances of resource-rich countries to avoid the resource curse hinge on the existence of sound institutions. While several initiatives have emerged to promote the transparency and sound management of natural resource revenues (NRR)— including IMF’s Resource Revenue Transparency Guide and the EITI, there is still a need to develop an overall framework for the assessment of NRR-related political economy and governance challenges. Against this background, the Bank has launched a project to develop a framework to assess and promote good governance in each of the stages of the “value chain” of NRR, from their extraction to their use, and incorporate political economy issues in the dialogue with resource-rich client countries. To refine such a framework, and concretize the timeframe for its implementation, the Bank held a workshop on October 16, 2008. The workshop revealed that the adoption of the usually proposed mechanisms to mitigate NRR-related governance challenges raises complex issues.

Budget problems in American states

Posted by Eivind Tandberg

Our colleagues at the Center on Budget and Policy Priorities in Washington DC recently published an interesting overview of the worsening budget situation of many American states (Download 9808sfp1.pdf), authored by Elizabeth McNichol and Iris J. Lav.  The report summarizes the fiscal challenges facing the states and describes the steps the states are taking to adress these challenges. Because most states, unlike the federal government, cannot run a deficit, economic downturns will generally have a more immediate impact on the states' fiscal situations.

According to the paper, at least 39 states are seeing shortfalls in their budgets for the current fiscal year compared to the initial budget. Flat or declining revenues are a major source of the shortfalls. Several states have also prepared estimates for future budget years and expect continued fiscal pressures. The paper lists steps that states are taking to reduce spending and close the budget gaps. These include reductions in education and social spending, as well as reductions in workforce.

Budget Amendment Powers Being Reexamined in South Africa

Posted by Ian Lienert

The South African Parliament currently votes on budget appropriations in their entirety. It could, in principle, reject an allocation to a particular department. However, the outright rejection of a departmental allocation would necessarily be interpreted as a vote of no confidence in the government. With a view to changing this situation, in August 2008 the South African Parliament received submissions on the new draft Bill that would provide Parliament with power to amend the executive’s proposed budget.

In an article recently featured in the International Budget Partnership’s 45, Len Verwey of the Institute for Democracy in South Africa (IDASA) highlights pros and cons of the draft legislation. Submissions by other organizations made similar points to those summarized below. For example, the National Treasury emphasized its desire to support Parliament in this process, as well as the need for a “fiscal responsibility” clause that would establish the parameters for any budget amendments by parliament.

How Effective are Aid Agencies?

By Tej Prakash

During the past decades, the total amount of external aid going to developing countries has increased greatly, and a great deal more has been committed in the coming years as a part of the Millennium Development Goals. The effectiveness of this aid depends upon many factors: the absorptive capacity in the recipient countries, their governance and managerial systems, and the effectiveness of their institutional framework. There is much literature on this subject. However, there is another side to the story that has not been explored as much: how much of the blame or credit goes to the aid giving agencies; can any lessons be learnt from the experience so far, both from the policy and the practice of giving aid.

Two related papers, one by Easterly and Pfutze (Easterly, William, and Tobias Pfutze, 2008, “Where Does the Money Go? Best and Worst Practices in Foreign Aid,” Journal of Economic Perspective, Vol. 22, Number 2 (Spring), pp. 29—52)and the other by Easterly (Easterly, William, 2007, “Improving Aid Agencies,” Economic Policy, UK, pp. 635—678), explore this issue and examine the track record of aid agencies in the past decades, both in establishing aid policy and in the actual flow of funds. Based on the past experience of successful and not-so-successful aid, they ask three questions: what is an ideal aid agency, what are best aid giving practices, and have the aid agencies followed the best practices.

Allen Schick and Paulo Mauro Discuss Budgeting for Fiscal Risks

On September 17, at a well-attended FAD seminar, Professor Allen Schick and FAD Division Chief Paulo Mauro presented their views on "Budgeting for Fiscal Risks". Professor Schick is an acknowledged expert on the subject and, in 2002, wrote a path-breaking book with Hana Polackova Brixi and Sweder van Wijnbergen — "Government at Risk: Contingent Liabilities and Fiscal Risk"—published by the World Bank and Oxford University Press. This seminar was timely, given the fact that FAD has recently produced an IMF Board Paper on the subject "Fiscal Risks—Sources, Disclosure, and Management".

Professor Schick was quite complementary on the recent FAD paper and agrees with many of the recommendations contained in the Paper. Pr. Schick suggested that a clearer distinction between "fiscal risks" and "fiscal uncertainties" could be made:

- In the FAD paper fiscal risk is defined as the "possible deviation of fiscal outcomes from budget estimates or other projections";

- Pr. Schick provides an alternative definition which focuses on the "contingency of future revenues or expenditures on uncertain events";

An Apparent Paradox? What the Political Economy Literature on Fiscal Institutions Could Say about Second Generation PFM Reforms

Posted by Francois Michel

Research on the political economy of fiscal institutions has made considerable progress in the past two decades, with numerous contributions from major economists including, among others, Douglas North, Alberto Alesina, Allan Drazen, Andres Velasco, Mark Hallerberg, Gian Milesi-Ferreti, Roberto Perroti, Torsten Persson, James Poterba, Guido Tabellini, and Jürgen von Hagen.

The political economy of fiscal institutions

This progress is related to the more general, progressive emergence of comparative political economy, which in turn benefited from advances in econometric techniques, as a major field of economics. A good example is Persson and Tabellini's classic book on The Economic Effects of Constitutions, in which the authors seek to establish some causality between two constitutional choices (majoritarian or proportional representation; presidential or parliamentary form of government) and economic outcomes.

Another example is Mark Hallerberg and Guntram Wolff's recent article on Fiscal institutions, fiscal policy and sovereign risk premia in EMU (Public Choice, Volume 136, Numbers 3-4 / September, 2008). These authors attempt to take stock of Daron Acemoglu's remarks that endogeneity issues make the assessment of causal effects of institutions and constitution particularly difficult by showing that budget institutions influence the perception of countries' default risks by financial markets (less subject to endogeneity problems).