The Functions and Organization of Ministries of Finance

Posted by Richard Allen, Yasemin Hurcan, and Maximilien Queyranne[1]

The paper sets out a taxonomy of government finance functions. It defines three broad classes of function—policy, regulatory and transactional. Policy functions such as undertaking fiscal policy analysis, developing new tax policies, or formulating the annual budget represent finance ministries’ core business and need to be retained at the center. Many regulatory and transactional functions, however, can be outsourced or devolved to line ministries or executive agencies operating independently or under the jurisdiction of the finance ministry.

To some extent, the notion of a unified “ministry of finance” has become outdated. Some countries choose to centralize all or most of their core finance functions in a single entity, usually the ministry of finance. Other countries choose to distribute the functions among two or more ministries, often for political reasons, perhaps to dilute the power exercised by a single finance minister. Examples include Australia, Brazil, Canada, Germany, Turkey, the Philippines, and the U.S.A. In addition, many countries have also adopted various forms of an “agency model” in which semi-autonomous entities are created to carry out specialized finance functions such as debt management, public procurement and revenue administration. The establishment of independent fiscal councils with responsibilities in the areas of macro-economic forecasting and the appraisal of fiscal policies is another example of this trend, notably in Europe.

Functions usually regarded as “core” finance functions are thus not always performed by the finance ministry these days. In OECD countries, for example, over 90 percent of finance ministries are responsible for managing the preparation of the annual budget and over 80 percent for tax policy, but less than half are responsible for macro-economic forecasting or public investment planning. In a sample of developing countries reviewed in the working paper, these percentages are even lower.

Looking at an important sub-group of finance functions, namely treasury operations (cash planning and cash management, accounting and internal control), the working paper identifies a similarly wide variation in approach. In a sample of countries at varying stages of development, about one-third carried out treasury functions centrally in a department or directorate of the finance ministry (the centralized model); in another third of cases the functions were carried by officials of the finance ministry operating as accountants or financial controllers in line ministries (the deconcentrated model); and in a further third of the cases the functions were fully delegated to line ministries (the decentralized model).

In terms of the way finance functions are organized and carried out, the paper draws an important distinction between the traditional or “classical” model of finance ministries and the “emerging” model which was strongly influenced by New Public Management (NPM) theories of the 1970s and 1980s, together with developments in organizational theory in the private sector. The emerging model is characterized by a strong emphasis on open communications, transparency in processes and data dissemination, flexible organizational structures, and the devolution of many transactional functions to line ministries and specialized agencies.

Some elements of the “emerging” model have flourished in the aftermath of the global financial crisis, notably the emphasis on transparency and accountability, which has put the spotlight on finance ministers to better manage public finances. Other elements are under scrutiny. In particular, by devolving or decentralizing transactional functions, the finance ministry may lose control over spending unless strong safeguards are put in place, and fiscal risks may be incurred. The paper observes that in the aftermath of the global financial crisis many countries have recentralized some of their financial controls in order to strengthen fiscal discipline, a partial reversal of the trend observed since the 1980s.

Organizational restructuring of finance ministries is most likely to occur during periods of economic or financial crisis (New Zealand in the 1970s, Turkey in 2001), dramatic political change (U.K. in the 1980s under Prime Minster Thatcher, Uganda in the early 1990s), or constitutional change (Chile in the 1980s, South Africa in the mid-1990s).  Most organizational changes take place incrementally, step-by-step; a full restructuring of the entire finance ministry is much rarer. Reform is also influenced by the development of new technologies (FMIS for example) which have transformed the bulk processing of accounting and internal control transactions that traditionally are very labor-intensive activities.

In the face of inevitable economic and fiscal shocks, the finance ministry usually finds itself in the front line of defense. After the global financial crisis, for example, it was imperative for some countries to build up their capability to manage failing financial institutions or to take them into public ownership. At other times in recent history, finance ministries have responded to different economic and political demand—at one time fighting inflation, at another time managing a large privatization program, at another facing the challenge of a political decision to give independence to the central bank, at another managing a local government financial crisis, and at another dealing with a major tax reform initiative. An efficient and effective finance ministry needs to respond nimbly to such demands by moving the necessary resources and skills into the areas most needed. Nimbleness requires flexibility in organizational structure, strong and decisive leadership, not to mention building consensus for change among officials at all levels of the ministry. 

Which of the models and approaches presented in the paper can be recommended to finance ministers who want to reform their functions and organizational structure? The paper offers some general principles to guide decisions in this area, but there is no simple answer to the question. They include integrating core policy functions in a single finance ministry which would focus on strategic policies (e.g., fiscal policy and reporting), and would need to build capacities in these areas. This would ensure that finance ministers exercise a strong role in agenda setting and shaping policy across the government. In parallel, the ministry of finance would transfer specialized finance functions (such as debt management) to arms’-length agencies, devolving transactional functions (budget execution, payment processing) to line ministries.

This approach requires that appropriate controls are in place within the ministry of finance to ensure that the agencies and line ministries have the capability to carry out devolved functions efficiently and effectively. The ministry of finance will need to monitor the line ministries’ operations and performance, and take action where necessary to deal with unforeseen developments. However, this approach will not be suitable to all countries, and will need to take account of a country’s historical, political and administrative context, the overall arrangements for organizing and managing the public service, together with the availability of human resources, skills and IT systems.