Ministries of Finance in Small, Developing Economies – Their Role and Structure

Tej Prakash

June 17, 2009

Posted by Tej Prakash.

Finance2 The Ministry of Finance (MOF)[1] has been the keeper of the public purse in nearly all countries almost as long as nation states have existed. Its role and mandate has evolved over time reflecting requirements of political and economic management. This article looks at the core roles of MOFs, specifically in small developing economies, and asks the question how best can they perform this role given the constraints faced by these economies

While there is no standard model for the organizational structure of a MOF, it is generally agreed that there is a set of core tasks that any MOF should fulfill. This includes (1) budget formulation and implementation, (2) collection, custody, management, accounting, control and disbursement of public monies, (3) management of public assets and liabilities, (4) revenue and expenditure policy and management, and (5) design and implementation of macroeconomic and fiscal policies of  government. MOFs have also added many other tasks such as donor coordination, oversight of domestic financial markets (often by establishing regulatory bodies) [2], managing fiscal risks arising from various sources, financial oversight of public enterprises, and relations with international organizations such as the World Bank and the IMF. It also often takes a lead role in designing and implementing the government’s overall economic policies. The global financial crisis will cause governments in many countries to review the roles and responsibilities of the finance ministry, and how these are carried out.

The organizational structure of MOFs is also linked to the political-economy and to the governance structure of the country. Countries with presidential or parliamentary systems will likely have different organizational roles and structures of the MOF. Presidential systems typically have a separation between the budget formulation function and the other traditional MOF functions. Countries with a federal or unitary structure will have a MOF that reflects their political, economic and geographical requirements. Finally, democracies place different demands on MOFs than an autocratic regimes. The objectives and the structure of the MOF will reflect these varying roles[3].

The MOF as an institution also reflects the historical legacy of countries. Many formerly colonized countries inherited the institutional systems of their former rulers. Thus Francophone Africa largely followed the French model while former colonies of the UK followed the British system. The focus of these models was largely to ensure control and compliance, and thus elaborate rules underpinned these systems. The role and the organization of the MOF in these economies mirrors to a large extent the MOF in the country that colonized them. This role has often evolved in advanced economies to meet the demands of modern market economies, while in the former colonies institutions are still evolving. This institutional evolution is also needed to provide the budget management system of government an  increasing focus on results.

Challenges faced by MOF’s in small, developing economies

In many small, developing countries MOFs have been struggling with the increased requirements of their core role as well as of more complex processes and other innovations. For example, financial sector development and instruments have posed increasingly complex challenges for MOFs. In many cases MOFs are now required to supervise or run investment funds. There is little skill in these countries to invest these funds so as to minimize risks while seeking a market rate of return. There have also been cases in the recent years where this lack of capacity has led some of these countries to entrust management of these funds to external fund managers, often with disastrous results. The modern MOF needs to supervise and regulate, along with the central bank, the domestic financial sector. Thus while these economies are small and do not have the capacity that larger, more advanced economies have, they still face many of the same problems, including the impact of the global financial crisis on public finances.

Lack of capacity effects several other areas. The MOFs in small developing economies lack the capacity to perform many complex tasks such as assessing the risk to the economy from external shocks and the ways to deal with it. These countries may also lack the expertise to manage public sector financial assets (such as pension funds) properly; or to enter into  public-private  partnerships where sophisticated contractual obligations can result in major economic damage.

MOFs in such economies also lack professional staff in many skill areas, such as treasury management and accounting. In many such areas not only the MOF but the whole public sector competes with the private sector for available talent. Experts in many such areas tend to prefer the private sector since it pays better. Also, most trained staff also tends to migrate to other more successful economies. For example, trained professional from South Pacific island countries tend to migrate to Australia or New Zealand, and from Lesotho and Swaziland to South Africa. The only way to retain such trained staff is through a combination of financial incentives and professional opportunities.  In the absence of trained professionals, many otherwise simple technical budget reforms such as in accounting become almost impossible to implement.     

Some innovative approaches to MOF organizational structure

In small developing countries it might be worthwhile to think outside the box with respect to the desirable institutional structure. Innovations could be sought through partnerships, delegation and  outsourcing of tasks, and seeking synergy in similar tasks. 

A first strategy could be to seek strategic partnership with other domestic institutions to manage some tasks on an agency basis. This should be done with a clear recognition of  the principal-agent relationship. The central banks in developing countries generally have greater resources as well as more trained professionals in many areas than the MOF. It is better placed to perform certain tasks as an agent of the MOF such as managing government’s financial investments, oversight of financial markets, debt management and macroeconomic forecasting and planning. Even in some advanced countries, the central banks perform certain treasury-related tasks on behalf of the MOF as its agent.

A second strategy is to depend upon the expertise available in another neighboring country. For example, New Zealand and Australia can play such a role in the case of South Pacific island countries and South Africa in the case of Lesotho and Swaziland. Usually this would only be acceptable for politically not so sensitive issues, such as fiscal statistics, debt management and investment advice. 

A third strategy for smaller economies, especially small island economies, could be to  establish a common Regional Fiscal Institution (RFI) to perform some of the MOF tasks.  RFI is not a variant of the regional training institute where training facilities are set up as a partnerships between several MOFs, regional centers of learning and donors who can provide financing. The concept of the RFI is more ambitious. It could be broadly modeled after the success of regional central banks. Regional monetary and currency union have in many cases been reasonably successful. Thus, arguments can be made for a RFI for performing some critical technical fiscal tasks on a regional basis. Main arguments against such a regional approach would be that the social and economic situation and demands of countries differ, and that political sensitivities prohibit joint activities.

There are a number of technical areas where a common approach is possible. Some areas suggest themselves: macroeconomic and fiscal baselines and analyses, financial liability and asset management, public-private partnerships and fiscal statistics. The RFI, can hire the necessary expertise, and perform tasks for the member economies on an agency basis. This will have the additional advantage of providing the countries a sound basis for budgeting and medium term scenarios without any political-economy biases. Establishing a RFI for example could be envisaged for small island economies of Pacific and the Caribbean.

RFI is not, it is important to emphasize, modeled after rule making and enforcing  institutions such fiscal councils or a common central banks. It is more of a decentralized MOF that can build capacity for performing advanced technical tasks, on an agency basis and on behalf of participating MOFs, that individual MOFs lack the capacity to perform. These tasks have been mentioned above. Over time, it might evolve into something approaching a regional council for coordinating policy response in areas of common interest.          

Finally, in many areas the MOF tasks can be organized so as to seek greater synergy between functions.  Some of core MOF’s functions in many countries have been devolved to other ministries. The most common example is the ministry of planning which takes over functions of economic planning and control over capital spending. In small economies facing capacity issues, this fragments fiscal and financial management and there is a strong argument for combining these functions in the MOF.

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[1] The MOF is also called the Treasury in some countries.

[2] In the U.K. this function was traditionally carried out by the Bank of England (BOE) and, more recently, by a tripartite arrangement involving the BoE, the Treasury and the Financial Services Agency.  Further changes are expected following the financial crisis.

[3] In some countries, the core functions of the MOF are divided between more than one ministry.  For example, in countries such as Australia, Canada, [France] and the U.S. there is a separate ministry or agency responsible for preparing the budget.  In some countries macroeconomic forecasting is the responsibility of the ministry of Economy.  And in countries with a national plan, the capital budget is often prepared by the ministry responsible for planning.

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