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October 18, 2010

Independent Fiscal Agencies for Developing Countries – A Technocrat’s Dream?

By Richard Allen

On September 27, an important new volume of papers on economic policy in developing countries was launched by the World Bank.1 The book, a “handbook” on the future of economic policy in the developing world, has attracted much attention in the media, not least because of its headline prediction that by 2015 developing countries will take a bigger share of world GDP than advanced countries.

The volume provides a lot of sound policy advice, and is strong on the important idea of strengthening fiscal institutions as a core requirement for improving growth prospects in the developing world.  However, some of the book’s ideas are less good than others. In particular, one suggestion, highlighted at the press launch, is that developing countries should consider establishing independent fiscal agencies as a protection against bad economic policies, and to mitigate the influence of corruption, since many developing countries do a poor job in respecting and enforcing agreed fiscal policy or fiscal rules. 

The book observes (page 11) that: “…independent fiscal agencies will become more common. They will increasingly become the credible, neutral parties that monitor compliance with fiscal norms, cost out initiatives, evaluate impact, and validate forecasts – credit rating agencies do some of this, but lost credibility during the crisis.” It is noteworthy that the book frequently uses this interesting trick of presenting policy recommendations masquerading as predictions.

An even more challenging idea, also dressed up as a prediction in the book, is that fiscal agencies may over time mutate into decision-making bodies, much in the way that central banks have assumed independent decision-making powers in the area of monetary policy. However, central banks generally operate within a tightly defined legal framework of rules (e.g., to maintain inflation within a specified range). While they are not immune from political pressure, most of their operations are largely technical or advisory in nature. In contrast, an agency with independent powers over the budget or public investment would be very different since the budget is at heart a political process, involving bargaining and horse-trading among ministers and the legislature to determine the appropriate allocation of resources. It is hard to conceive how such a process can be taken out of the political arena.
Before these ideas become the latest fad in Bank and IMF lending operations and technical assistance missions to developing countries, some further reflection is required in my view.

While independent fiscal agencies can certainly play a useful role in advanced countries, and perhaps to some extent in the larger emerging market economies, the proposal seems somewhat of a technocratic dream for less developed countries. Yes, the Congressional Budget Office (CBO) in the U.S. has been a success, and many EU countries such as the Netherlands, Sweden, and most recently the U.K., have established such bodies, whose role has been favorably assessed by the European Commission.  In some middle-income countries such as Hungary and Slovenia, fiscal agencies have also recently been established, but it is still too early to assess their contribution to fiscal management.

Establishing independent fiscal agencies, however, is generally not good policy advice for developing countries, and could be profoundly dangerous. There may be exceptions to this general rule – for example, the independent committee of experts that is being established in Mongolia (based on the successful Chilean model) to make projections of mineral revenues – but here the mandate is quite narrow, and the reporting arrangements (to the finance ministry) tightly defined.

Consider some of the important preconditions that need to be in place for such agencies to be a success.

First, fiscal policy needs to be determined by an orderly process, and be subject to clear procedural rules and guidelines. Independent fiscal agencies do not make policy, they interpret it and comment on it, and there needs to be an audience in the finance ministry who is both responsible for taking action on the basis of such advice, and has the capability to do so. The book advocates the establishment of fiscal rules and medium-term expenditure frameworks, initiatives that, again, have worked quite well in some advanced countries, but less well in the developing world, precisely because ministries of finance lack the organization and skills required to put in place such frameworks and ensure that are implemented.

Second, proper accountability arrangements need to be established. To whom will the independent agencies report on a formal basis? How can potential conflicts of interest be avoided? These are not easy issues to resolve, even for advanced countries. The newly established Office of Budget Responsibility in the U.K. was initially criticized for being an offshoot of the finance ministry (HM Treasury) and using the Treasury’s economists as staff. The CBO has a clear reporting line to the U.S. Congress, but how can such arrangements be replicated in a country with a very weak parliamentary system, or where the parliament has a vested interest in promoting economic and fiscal policies that satisfy local constituencies and lobbying groups, but are not necessarily in the wider public interest?  If the independent fiscal agency reports to the President, or to the Prime Minister, or to the government collectively, in what sense is it truly independent?

Finally, many developing countries are desperately short of skilled economists and fiscal policy analysts. Where are the resources required to staff up an independent fiscal agency to come from? From the finance ministry, which itself is in urgent need of such skills and talent? From the central bank? From independent think tanks? In many countries, there is a risk that creating such an agency will deplete the government of the skills and talent that it badly needs to manage the public finances.

1The Day After Tomorrow: A Handbook on the Future of Economic Policy in the Developing World, edited by Otaviano Canuto and Marcelo Giugale, World Bank: Washington D.C.

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