Posted by Gösta Ljungman
Imagine that you and your friends are planning a New Year’s dinner party. You have to decide what to serve as a starter, what the main course will be, what type of dessert you will have, and which wine—if any—you are going to drink. All of these decisions have consequences for the total cost of the dinner, which you will of course split equally. You, being concerned with the impact that the global financial and economic crisis has had on your household budget, but also wanting a good party, are pondering how to structure this decision making process. After all, remembering Kenneth Arrow’s impossibility theorem, you realize that there is no single method for reaching consensus that is truly democratic.
The question you ask yourself is: should the decision be taken in a top-down or a bottom-up sequence?
If you and your friends agree on the first— that is, a top-down—approach, you start by setting a maximum limit for the cost of the dinner party. Once you have agreed on this, you decide on how much of the total budget you will spend on the various courses and drinks that are going to be served. Only at the third stage do you sit down and make a list of the ingredients needed for each dish, observing of course the cost limits that you set earlier.
If on the other hand you chose a bottom-up approach, you would start by deciding on a starter, move on to the main course, then the desserts, etc. The exact cost of the whole dinner would be the sum of a number of individual decisions, and would not be known until the after-dinner mint had been chosen.
Which of these decision-making procedures brings you closer to you and your friends’ preferred trade-off between what you pay and what you get? You may think that the top-down approach would be more kind to your wallet, and would lead to a lower total cost. In fact, this is not necessarily the case. It is not possible to say a priori how the sequencing of decisions affects the size of the budget. A top-down budget decision-making process can both lead to a more expensive, or less costly, feast; the outcome depends on how strongly you and your friends individually feel about your choices for starters, main course, dessert, and wine.
Should we from this example draw the conclusion that we cannot say which budgeting approach is better? In the simple world of organizing dinner parties, the answer is probably yes. In the more complex environment of negotiating a state budget, a top-down sequence of making budget decisions will both help preserve fiscal discipline and promote proper prioritization between competing requests for public money.
To see why this is the case, the budget process has to be recognized for what it really is: a very large number of decisions taken under a time constraint by individuals who have far from full information of the implications of various alternatives. These imperfections in the budget process make a bottom-up approach particularly ill-suited to arrive at a decision that balances the myriad of different objectives against each other, including the important objective of ensuring that the budget is sustainable.
First, a typical budget consists of hundreds, or even thousands, of individual spending decisions. As opposed to the dinner party example—where a handful of people have to decide on four or five issues—it is practically impossible to take into account all cabinet members’ or parliamentarians’ preferences when deciding on each appropriation. The rational tactics for decision makers is often to choose one’s battle, and focus on a few issues that are close at heart. This means that those who feel strongly about securing money for a particular objective tend to have a disproportionate influence over that individual spending decision.
Second, budgeting is to a large extent a frantic scrambling trying to reach consensus before time runs out. In most other circumstances, if it becomes obvious that less than ideal decisions have been taken—for example if in the eagerness to celebrate the New Year in style, you realize that there will not be enough left for the January rent—it is possible to go back and reconsider. This option is rarely available when deciding on the state budget, which means that you may be left with a less-than-ideal budget simply because you ran out of time.
Third, the financial consequences of decisions are often only fully understood by the civil servants who deal with the issue at hand on a daily basis. This asymmetry in information can have drastic consequences if the budget is decided without any reference points in terms of ministerial or sectoral spending limits, against which individual ministers can be held accountable.
In his blog posting of August 26, 2009, Marc Robinson made made the crucial point that the dichotomy between top-down and bottom-up is an abstraction made to illustrate two approaches, and that in reality, all budget processes have to involve both top-down and bottom-up elements. A complete disregard for how individual spending decisions will affect the bottom line in the budget is blatantly unrealistic. It is equally impossible to imagine the imposition of top-down limits on expenditure without some assurance that basic public functions can be continued, and the government’s main priorities be implemented. That said, strong top-down elements in budget preparation and approval help countries celebrate the coming of the new year, confident that guests are happy and bills can be paid.
For a more comprehensive discussion on the issue of top-down budgeting, see:
http://www.imf.org/external/pubs/cat/longres.cfm?sk=23327.0
