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).
These recent developments were well prepared by the mainstream political economy literature that was already mature by the 1980's (cf. Richard Katz, Arend Lijphart, James Alt and Alec Chrystal). But they also followed the development of formal models of political economy, of which Allan Drazen has provided a landmark treatment with his celebrated book Political Economy in Macroeconomics. This movement is often referred to as "new political economy".
The literature on fiscal institutions has also benefited from adopting a more microeconomic approach, focusing on moral hazard issues within well-defined organizational arrangements, and has thus been a prolific field of application to numerous concepts from new institutional economics. In this vein, Jürgen von Hagen underlines two issues in a recent article: the principal-agent relationship between voters and politicians (and the considerable residual powers from the latter); and the common pool problem of public finances.
Scoring budget institutions?
However, much remains to be done on identifying precise indicators of "good budget institutions" that can be used in microeconomic models and serve as structural variables for comparative purposes. This need to "unbundle institutions" has been forcefully made by Daron Acemoglu and Simon Johnson in a more general context.
In fact, while it is true that fiscal institutions may be described through certain taxonomies - see the World Bank or the OECD's databases on budget practices - the production of institutional scores or indexes (such as those introduced after von Hagen's model, for instance by Holger Gleich for Central and Eastern European countries) remains a very difficult task.
In particular, this approach has yielded limited results in terms of particular recommendations of country-specific institutional arrangements. One reason is that scores, even when based on questionnaires rather than on the analysis of laws, as Alesina and Perotti recommended in their 1996 paper on Fiscal discipline and the budget process, may still not capture "de facto" budgetary procedures.
In an effort to address these challenges, large providers of technical assistance have developed a comprehensive PFM rating system, the Public Expenditure & Financial Accountability (PEFA) framework, which is applied through expert in the field. However, this framework is recent (mid-2005); to date it has been applied mainly in low-income countries, though recently in more middle-income countries such as Indoensia and Ukraine and one OECD country (the PEFA self-assessment undertaken by Norway - see the recent PFM Blog post on this assessment); and little statistical work has been done on the results.
Reconciling the literature and second-generation budget reforms
But there seems to be a more troubling issue: among the available results from the literature on "scoring" attempts, the most positive conclusions seem to be that centralism - embodied in a powerful finance minister, "who can monitor spending ministers and punish those who defect", or brokered through fiscal contracts for multi-party governments (see Hallerberg and von Hagen, 1997) - is preferable to the delegation of large spending authority to line ministries for over-all fiscal balance.
At the same time, second-generation PFM reforms such as output-based budgeting seem to aim exactly at the opposite direction: the devolution of spending envelopes to line ministers (who are accountable for service-delivery results). This is what I called the "paradox of the second generation PFM reforms".
The reader will recognize that this is only an apparent paradox, since second-generation reforms presuppose that sound budgetary practices are already in place and that, in particular, the minister of finance is powerful enough to execute the budget as voted by parliament. In addition, PFM reforms are not only concerned with the management of overall budget execution, but also with the efficiency of delivery of public services. This notion is typically absent from available studies on fiscal institutions.
However, this still emphasizes the difficulty that budget experts face in reconciling conclusions of the political economy literature on fiscal institutions and of country-specific reform plans. The recent report on "The political Economy of the LOLF", France's new budget system law, by the Conseil d'analyse Economique may also be illustrative of this difficulty: it ignored the recent developments of the literature mentioned above and concentrated on the notion of revealed public preferences, a notion that was actively debated in the 1970's and 1980's.
