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April 18, 2011

Waste in Government Expenditures

Posted by Sanjay Vani, Lead Financial Management Specialist

In this period of fiscal crisis and tightening of public expenditure budgets, it is especially interesting to look at the extent to which public expenditures are wasted. It is generally assumed that in developing countries a large portion of public expenditures is lost to fraud, waste, and corruption—as some high-ranking officials have been candid enough to admit. For example, when Rajiv Gandhi was Prime Minister of India, he famously remarked that for every one rupee spent on poverty alleviation programs in India only 15 paise (i.e., 15%) reached the intended beneficiary. But it turns out that wasteful government expenditure is not just a problem of developing countries. Three OECD countries with large economies—the United Kingdom, the United States of America, and Japan—can serve as examples.

  • The United Kingdom. The new UK government headed by Prime Minister David Cameron recently commissioned an efficiency review of Government spending, focusing on procurement, property, and major contracts. The report, now known as the Sir Philip Green Report, highlighted a number of examples of inefficient government spending. One of the findings of the report is the existence of significant price variations across central government departments for the purchase of the same product. For example, to purchase a box of paper one department paid £8, while another paid £73—nine times more! And to purchase printer cartridges, one department paid £86 while another paid £398! Although the report does not put a number on the total waste, it asserts that the number is quite big.
  • The United States of America. The GAO Report on the Fiscal Year 2010 US Government Financial Statements estimates that improper payments (payments that should not have been made or that were made in an incorrect amount) by Federal entities totaled $125.4 billion for fiscal year 2010 (up from $110 billion in 2009). For example, the Federal Government paid out benefits totaling more than $180 million to approximately 20,000 Americans who were dead; paid more than $230 million in benefits to approximately 14,000 fugitive felons, who are not eligible for benefits; and spent $35 million for a radio navigation system for ships, when much cheaper GPSs are readily available.  Although the $125.4 billion represents only about 5.5 percent of the Government’s total outlays of about $2.3 trillion, the amount is staggering. Alarmed at the increasing size of improper payments, and concerned to cut waste, fraud, and abuse, in July 2010 President Obama signed a new law, “Improper Payments Elimination and Recovery Act.”
  • Japan. The audit report for the year 2008 identified expenditure-related improprieties amounting to the equivalent of $180.5 million.

Many developing countries suffer from weak accountability institutions, and their progress and reforms are hampered by generally weak capacity.  However, the UK, the US, and Japan do not face such constraints:  they have strong accountability arrangements, including a strong and independent supreme audit institution, free media, a strong civil society, and a large work force of educated and skilled people. Moreover, these countries are not known to suffer the endemic corruption that is common in many developing countries. So the obvious question is, why is there so much waste in public expenditures in the developed world?  I conclude that there are two main reasons:

  • There is no incentive for government departments to save money. In the corporate world, the fate of top management is often tied to the bottom line; there is some incentive for the management to not undertake “imprudent” projects or spend £73 on a box of paper instead of £8. It is not that the corporate world has tighter controls or better audit systems; the difference is that when quarterly earnings[1] are announced, the stock market provides an instantaneous reaction.[2] There is no equivalent mechanism for either the voters or anyone else to react when government departments post periodic fiscal data on their website. Just imagine if the department spending £73 on a box of paper were to reduce the expenditure by negotiating a reduced price of, say, £60. No one would even notice that; indeed, there is even a slight possibility that this department’s budget may be reduced next year because it did not spend this year’s allocated budget!
  • Procurement in government is more procedural than commercial. The procurement function is more concerned with complying with myriad rules and procedures than with maximizing value for money. Commercial acumen is generally missing in government procurement, perhaps because form is considered more important than substance:  procedural mistakes could attract attention from the control and audit agencies, while full compliance with rules and procedures—even if it leads to paying £73 per box of paper—would hardly attract any attention. 

Other factors also contribute to waste in public expenditures:  lack of “intelligent” information systems able to collate, compare, and connect the dots on a real-time basis, and lack of a rigorous process to challenge departmental budgets and expenditures (imbalance in autonomy and accountability).  Moreover, the sheer size of a department sometimes makes controls that work elsewhere ineffective (the U.S. Department of Defense was reported to claim that it is just too big to audit!).

To conclude:  developing countries do not have a monopoly on wasteful public expenditures. Despite the presence of strong institutions and a watchful civil society, some waste in public expenditures occurs even in developed countries.  Minimizing such waste means thinking beyond prescribing more controls and more audit; instead, it would require new, out-of-the-box thinking on how to devise incentives for the efficient management of public resources.



[1] The quarterly earnings report is a “report card” of sorts for listed companies. It is through these reports that companies let market participants know how well they have performed during the period. Analyzing this information helps investors gauge the financial health of the company and decide whether or not it deserves their investment.

[2] It can, of course, be argued that in the light of the recent financial crisis, which was caused by private sector institutions, we do not dare to draw any inspiration from the private sector. However, the point here is not to promote adopting private sector practice, but to highlight the absence of a mechanism similar to the private sector’s, where the results announced by corporate entities bring an instantaneous consequence.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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Comments

Some good points there Sanjay.
I would say that not only do government departments have no incentive to save money, they actually have a positive disincentive to do so, given the way budgets are formulated in most countries. The way it works is that most Departments perceive a larger budget as better, and this is the basis on which their performance is judged both internally and amongst peers. As a result they must spend what they have this year to enable them to make a case for the next. Budget Departments also send a wrong signal by responding to this tactic and actually cutting budgets of departments which were unable to spend their allocations (“you could not spend last year therefore you did not need what you asked for- ergo you also need less this year because you have not proven your ability to spend”). As a result, we have a vicious cycle of demanding more and spending more, to get more in subsequent years in most developing countries. Most of this spending gets incurred at the end of the fiscal year and a rush of expenditure at that time. So the systemic incentives are actually perverse.

If the U.S. discovered the improper payments, how many of them were cancelled, collected, or rescinded? It is not wasteful if the mistake is caught and corrected. Waste is the hardest thing in government to detect, because it occurs when no official knows about it or when an official knows and chooses to do nothing (and normally hides the fact).

if capacity building or rules making are not reviewed at regular intervals these type of abberations are bound to happen be it developed or developing economy, they are to be consistent with the time. Strict control mechanism has to be really strict in a given time frame.
parag prakash

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