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Posted by Richard Allen and Francesco Grigoli

A recent World Bank study investigated the factors that make a ministry of finance (MoF)—or more broadly defined the finance agencies at the center of government—an effective and crucial instrument for economic development.^[1] One of the key findings is that an effective finance function is less about capacities, the number and quality of staff and systems, and more about the capabilities to use these capacities in the political and bureaucratic environment. Politics often gets in the way of the effective management of government resources. Another interesting finding is that centralization of powers in the MoF is important in less developed countries, to control expenditure and assure the strategic direction of government expenditures. For middle-income countries, however, decentralization of operations to line ministries is desirable to ensure effective implementation of government programs and avoid inefficient and unnecessary input-based controls.   

The study affirms that a well-organized and effective finance ministry and its associated central finance agencies (CFAs) are essential to good fiscal outcomes. CFAs are not a single organization or entity of government but a group of ministries and agencies, of which the MoF is usually the most prominent, with collective responsibility for the design and execution of a country’s wide array of financial and fiscal functions. CFAs deliver central finance functions that can be divided for convenience into the 16 categories shown below.

 Download Central Finance Functions

The allocation of roles and responsibilities for central finance functions among government agencies varies substantially from country to country and results in higher or lower degrees of fragmentation. There is no “best practice” model. In some countries, the central MoF employs more than 100,000 staff, partly because staff-intensive functions such as tax administration are included as departments of the MoF. In other countries the size of the MOF is less than 100. Such huge variations are not only related to easily quantifiable factors such as population size and the size of the public sector, but also to a range of informal “political economy” factors.

The study makes an important distinction between the capacity and capability of CFAs. “Capacity” refers to the volume or scope of inputs such as human resources or ICT systems. “Capability” focuses on how such volumes can be converted into better performance through mechanisms such as clarifying roles and responsibilities in performing CFA functions; strengthening arrangements for coordination and information-sharing within and across CFAs; clarifying relations with line ministries, civil society groups, development partners and other stakeholders; improving the management of internal business processes such as decision-making hierarchies, corporate planning, and information systems; and strengthening the management of human resources, and internal incentives.

In practice, many countries have focused attention on strengthening capacity, with less emphasis on strengthening capability. The two concepts are typically linked: where capacity is low, capability is also likely to be limited. However, this relationship does not hold in all cases: a weak configuration and/or organization of inputs, and a high-cost operating environment, perhaps also marked by institutional constraints such as a finance minister who lacks a power base within the government, may mean that even when capacity is high, capability may be low.

Case studies 

The study highlights some common themes and features for a set of 10 low-income countries.

First, in several of the countries studied the head of state or prime minister plays an unpredictable and capricious role in making executive decisions on the budget and financial policy. While such powers are normally exercised within the framework of the constitution and budget law, they are not always compatible with the idea of an orderly and transparent budget process. In fact, in these countries large tracts of the fiscal process seemed to be outside the direct influence of the finance minister, and off limits from a reform perspective.

Second, it was observed that in these countries the head of state uses his political authority to divide the financial power attributed to the minister of finance among several ministers. Such actions are often taken to avoid the accumulation of excessive authority in the hands of one person, and to preserve the discretionary powers of the president or prime minister over resource allocation and the collection of resource revenues. Another reason is that ministerial portfolios provide not only access to “rents” but also accommodate factions within the ruling coalition. 

Third, many low-income countries have poorly organized finance ministries, inadequate staff records, poor systems for recruiting and retaining staff, ineffective performance management, inefficient top management structures and overly-hierarchical decision-making processes, and ineffective use of ICT systems. Reorganizing central finance functions is a challenging process that is likely to meet opposition from both politicians and staff. Moreover, there is an absence of international benchmarks to guide reform processes.

Fourth, the study supports the results of other work that weak coordination among donors—and between donors and their clients in finance and planning ministries—is a major problem in designing and implementing coherent strategies for reforming CFAs and PFM systems. Moreover, reforms of CFAs and PFM are often influenced by donor requirements, with insufficient “ownership” by the government concerned.

The organizational structure of CFAs

Data collected on the organization of central finance functions show that: at low-income levels countries often have highly fragmented CFAs in which control of public finances is divided according to powerful political groups and, as discussed, by heads of state/prime minister who deliberately fragment the authority of the finance minister in order to boost their own authority. Dispersed manual systems of accounting, reporting and financial control tend to reinforce this phenomenon.

As countries move to middle-income status, pressures to consolidate financial activities within the finance ministry increase, often with the encouragement of the international financial institutions. This trend has both a technological aspect (to increase overall fiscal control) and a political aspect requiring greater accountability and transparency: the emergence of a professional middle class holding the government to account for fiscal performance, a less dominant role of rent-seeking in driving budget allocations, the rise in power of the finance ministry as an institution of government, the increased political importance of the annual budget, and increasing reliance on international capital markets as a source of finance.

In high-middle income countries, the role of the finance ministry may change from directly operating the systems concerned to an oversight and monitoring function, while direct operations are transferred to line ministries and/or subordinate agencies responsible for treasury and procurement functions. In many operational areas, finance ministers may delegate operational responsibility for the activities concerned to subordinate agencies under their supervision. Fragmentation may therefore increase again—completing a “U-curve” pattern.

Concluding remarks

The study shows that political economy analysis of CFAs is highly relevant—indeed essential—to the design and implementation of new initiatives to strengthen CFAs. As a result, such analysis is valuable in filtering out reform proposals for which political economy factors are favorable to success from those where there is a high risk of failure.

Second, the study supports recent thinking that “best fit,” “good enough governance” and second-best solutions, as opposed to “best practice” solutions, provide a better approach to reform, and that there is a need to take account of the institutional environment as well as technical conditions. Technical solutions should be proposed only after a detailed review of institutions has been carried out. Solutions should be tailored to the specific political and institutional environment of the country concerned.

Finally, low-income countries should be encouraged to centralize their finance functions and be cautious about enacting policies—for example, fiscal decentralization—that do the reverse. Middle-income countries should be encouraged to gradually devolve authority for financial decision making to the agencies responsible for specific functions and programs, but without creating undue stress on their financial systems, and without relinquishing overall supervision and direction. For example, an overly rapid growth of autonomous government agencies has been a feature of developments in many middle-income countries, including in Eastern Europe and Central Asia, but without adequate safeguards and controls it can threaten the overall financial stability of these countries.  Devolution should go hand-in-hand with the building of institutions and the development of credible anti-corruption policies.