Budget Institutions in Latin America: What have we learned in the last decade? Ernesto Stein Research Department Inter-American Development Bank

Why the interest in BI? By 1994, when RES was created, fiscal accounts in Latin America had improved substantially: –1980’s deficits averaged between 5 and 10% of GDP –early 1990’s deficits had declined to 2 % on average, comparable to OECD. Yet, there were still reasons for concern: –improvement partly due to cycle, privatization receipts. –deficits still higher than OECD when normalized by revenues –striking differences across countries: from 2.5 % surplus in Chile to double digit deficits in Guyana and Suriname.

Why the interest in BI? In Europe, US, similar differences in performance across fairly homogeneous countries (or states) had led scholars to explore role of BI in explaining such differences, with encouraging results. So in 1994 we invited Alberto Alesina to visit RES, and together with Rudi Hommes and Ricardo, we started a project on BI and fiscal performance.

What do we mean by BI? They are the set of rules, procedures and practices according to which budgets are drafted, approved and implemented (Alesina and Perotti, 1996). These rules may take various forms: –numerical rules such as limits on debt or deficit –procedural rules, which define the attributes of the different actors that participate in budget process, and rule their interaction. –rules that affect the transparency of the budget.

Why would BI matter? Fiscal decisions not made by social planner. They are the result of collective process involving a variety of actors, each with its own motivations and incentives. This generates a number of potential problems, which good BI may help address. –Electoral cycle –Short term horizon of politicians –Principal-agent problems –The common pool problem

The common pool problem Stems from combination of two key features of public budgets: Government programs generate concentrated benefits, but are financed from common pool of resources. The budget is the result of a collective decision- making process, involving a variety of agents: –legislators, the finance minister, spending ministers, etc. Since most of them represent geographical or sectoral interests, under some institutional arrangements this may lead to overutilization of the common pool, thus to excessive spending or deficits. The tale of the chicken and the lobster.

Consumption of chicken and lobster in Latin America

How can BI address these problems? Numerical rules: If enforced, may help deal with many of the problems identified above. But: –generate incentives for creative accounting –unless cyclically adjusted, may reinforce procyclicality of fiscal policy (important feature of fiscal policy in LAC). Rules affecting transparency may limit agency problems by increasing accountability to voters. Procedural rules may help by making process more “hierarchical”, concentrating power on those actors that have incentives to deliver fiscal discipline

Do BI affect fiscal performance? International experience suggests that they do US: States with more stringent balanced budget rules have better fiscal outcomes (lower deficits, lower debt, adjust more quickly to adverse shocks) EU: J. von Hagen built index of BI based on –relative power of FM in cabinet negotiations –relative power of exec. vis a vis leg. during approval –Degree of expenditure control by executive Finds that more hierarchical BI reduce deficits and debt, without affecting capacity to stabilize output.

Do BI affect fiscal performance? LAC: AHHS built an index of BI based on a survey responded by budget directors in 20 countries. We found that more hierarchical BI lead to smaller primary deficits. Similar results for deficits and debt by Stein, Talvi and Grisanti (1998). Impact of BI robust, and economically important So BI do matter. Next question: What to do about it?

What to do about BI in LAC? Numerical rules? –Too inflexible for such a volatile region. LAC needed solutions that would induce discipline without exacerbating procyclicality. In this spirit, Eichengreen, Hausmann and von Hagen proposed creation of National Fiscal Councils –autonomous entity that would establish yearly debt ceilings, taking the cycle into consideration –additional role of setting macro assumptions, acting as autonomous scorekeeper between exec and legislature. NFC proposal generated heated discussions, but no takers.

Some recent reforms Towards the end of 1990s, reform of BI started to resonate in LAC policymaking circles inspired by: –findings of literature –experience of countries such as New Zealand with its Fiscal Responsibility Act of –crises context that required further fiscal adjustment In 1998, Venezuela created “Oficina de Asesoría Técnica del Congreso” (CBO style). In 1999, Argentina and Peru adopted FRLs, combining numerical rules with stabilization funds, changes in procedures and increased transparency.

Some recent reforms In 2000, Brazil adopted very comprehensive FRL, imposing constraints not only at national level, but also at subnational levels of government. In 2001, Chile adopted a 1% structural surplus rule. Latecomers to the FRL game: Ecuador (2002) and Colombia (2003)

Results have been mixed at best Venezuela: CBO flourished initially, but has been subject to considerable political interference during current administration. Argentina and Peru: Numerical rules component of FRL’s never complied with –In Peru, other aspects of the law (e.g. multiannual macro program, increased transparency) changed dynamics of the budget discussions, but overall experience can hardly be considered a success. Brazil: may be too early for definitive conclusions, but so far results have been encouraging. Chile: doing quite well under structural surplus rule –(but was doing well before).

BI reform: what lessons can we draw? Lesson 1: The business of reforming BI is is not an easy one. Lesson 2: When it comes to the design of reforms, the devil is in the details. –In Argentina and Peru, some aspects of the law were very poorly designed. ordinary law rather than special law (as in Brazil) no enforcement mechanisms (in Brazil there are severe penalties including jail for non-compliance, and automatic trigger mechanisms to adjust behavior when targets are approached) conditions for escape clauses in rules not clearly specified.

BI reform: what lessons can we draw? Lesson 3: While it may be tough to get these reforms passed, it is even tougher to make them stick. –Adequate implementation and enforcement requires an external enforcer (such as a capable and independent judiciary) or stakeholders interested in enforcing the rules, and powerful enough to do so. Lesson 4: The success of reforms depends on the institutional context in which they are embedded. A good understanding of the policymaking process (i.e., of the key political actors, their incentives and capabilities, the ways they interact, the political transactions they engage in) is a key ingredient for the successful design and implementation of reforms.

Budget Institutions in Latin America: What have we learned in the last decade? Ernesto Stein Research Department Inter-American Development Bank