Posted by François Michel
In a relatively recent survey of how five major US cities handle contracts in their budget (Public Budgeting & Finance Review, March 2006 - Vol. 26 Issue 1), Professor Irene Rubin from Northern Illinois University makes a convincing call for increasing contract reporting standards.
The survey’s results are a hard pill to swallow for budget savvy citizens or other interested taxpayers: even in municipalities with the most developed and transparent budgets, complex contracts remain practically unreadable in budget documents and are thus barely subject to any external scrutiny. This lack of transparency prevents any credible assessments of contract performance or comparison between in-house and external provision of public services. It also allows easy—and potentially manipulated—claims of costs savings by government officials. In response, Dr. Rubin recommends that each individual contract be systematically reported on an individual basis, with its scope, duration, cost, and performance requirements. Contract theory adepts would add that performance specifications should cover quantity, quality, cost and timeliness.
Calls for increasing contract disclosure requirements have become a regular theme of PFM fora in recent years. Such recommendations were issued by the IMF in the context of its recently updated Manual on Fiscal Transparency and in various publications on public-private partnerships (PPPs), of which service concession arrangements are a particular case. In fact, the universal development of large and complex contracts such as PPPs undoubtedly calls for stepping up public financial management tools, including commitment controls and contract disclosure requirements. A growing body of literature shows that PPP contracts need to be carefully and regularly reviewed by independent authorities since they can expose the government to hidden rent back-loading and since renegotiation inevitably occurs.
However, Ms. Rubin’s paper is most convincing in two ways: (i) it relates contract disclosure requirements to the very principle of performance budgeting; and (ii) it does not seek a solution to the current opacity of government contracts in simply stricter or more intelligent accounting regulations.
Performance budgeting has been defined by the OECD as a type of budgeting that links the funds allocated to measurable results. While there is no single model of performance budgeting, a key aspect of this type of budgeting is to ensure that performance information—reflecting both public policy options and their execution—is produced and used for expenditure prioritization and program evaluation, thus allowing “loosening input controls without losing control” (see our blog post on Performance Budgeting-Linking Funding and Results, Robinson, 2007, pages 38-40 and 113-120). Furthermore, the most recent experience of OECD countries show that adopting a clear program classification of expenditure only partially addresses the question: governments then need to set standards regarding the information content of annual performance plans and reports. Hence, setting up proper disclosure standards for contracts clearly appears essential for developing performance budgeting systems. This point may not have been sufficiently underlined in publications on the topic.
It must be acknowledged that the accounting community is progressively addressing the shortcomings of the PPP reporting requirements first introduced by the U.K. Accounting Standards Board and Eurostat. Yet, absent contract standardization, complex contracts simply cannot be individually represented as a stream of commitment and cash flow figures (which do not contain enough information). Contractual provisions need to be spelled out and they often differ from one contract to another. Consequently, neither performance requirements provisions nor guarantees (and hence commitments) can be meaningfully aggregated in global envelopes. There is no other option than reporting large contracts on an individual basis. In fact, PPP contracts allow the creation of additional economic value through complex incentive and risk-sharing arrangements that traditional procurement rules did not permit (see our blog Primer on PPPs). This brings a trade-off between economic efficiency and the simple, “aggregateable” representation of contracts in the budget that used to facilitate external scrutiny. Ms. Rubin’s approach of systematic and comprehensive disclosure of contract provisions is the right one, though cultural resistance will certainly be important.
