Contemporary Challenges in Managing Public Expenditures Allen Schick Training Course on Public Expenditure Analysis and Management The World Bank January 13, 2004

FOUR BASIC REFORM OBJECTIVES MAINTAIN FISCAL DISCIPLINE The government should aim to stabilize its fiscal position in the medium-term and beyond PROMOTE EFFECTIVE ALLOCATION OF RESOURCES WITHIN AND BETWEEN SECTORS The government should shift funds to more effective, higher-priority needs IMPROVE EFFICIENCY IN THE PROVISION OF SERVICES The government should encourage ministries and agencies to improve performance BUILD MODERN BUDGET AND FINANCIAL MANAGEMENT CAPACITY The government should strengthen the informational basis for managing public money

EACH OBJECTIVE IS ASSOCIATED WITH A CONTEMPORARY BUDGETARY INNOVATION MAINTAIN FISCAL DISCIPLINE Fiscal Rules that limit budget total PROMOTE EFFECTIVE ALLOCATION Medium-term expenditure framework IMPROVE SERVICE EFFICIENCY Performance-based budgeting MODERN FINANCIAL MANAGEMENT Integrated financial information systems (IFIS)

PUBLIC EXPENDITURE CONDITIONS ASSOCIATED WITH ECONOMIC DEVELOPMENT AS THE ECONOMY DEVELOPS EXPLANATION Public Spending Grows as a Percentage of GDP Rising expectations, strong demands for improved services, and easier availability of resources Consumption Expenditure Rises Initial increases tend to be concentrated in services such as health, education, environment, and sanitation Transfer Payments Rise Later As development persists and matures, pressure rises to establish/enhance social security programs Aggregate Fiscal Discipline May Weaken Budget deficits may rise as government overspends the dividends of economic growth and draws on its improved ability to borrow Pressure to Improve Allocative Efficiency by Shift from Subsidies to Transfers Pressure to remove/reduce subsidies to firms and to protect disadvantaged/dependent persons through income redistribution schemes and expansion of “safety nets” Operation Efficiency May Decline Citizen pressure for better services, impeded by failure of government to pay competitive salaries as private employment opportunities advance and inability of pre-development bureaucracies to keep up with new demands/opportunities, and greater opportunity for corruption

GETTING THE BUDGET RIGHT FISCAL DISCIPLINE. Are total revenue, spending and the surplus or deficit appropriate in the light of current and prospective economic conditions, the government’s taxing capacity, and demands for public services? EFFICIENT ALLOCATION. Are the government’s priorities right in terms of developing society, financing public objectives, and carrying out the programs authorized in law? EFFICIENT OPERATIONS. Is the government spending money and managing operations in ways that provide high- quality public services that give value for money?

BASIC REQUIREMENTS OF EFFECTIVE PUBLIC EXPENDITURE MANAGEMENT FISCAL DISCIPLINE Budget totals should be the result of explicit, enforced decisions: they should not merely accommodate spending demands. The totals should be set before spending decisions are made, they should be enforced during implementation of the budget, and should be sustainable over the medium-term and beyond. EFFICIENT ALLOCATION Expenditure decisions should be based on government priorities and on evidence concerning the effectiveness of public programs. Budgeting should facilitate reallocation from lesser to higher priorities and from less to more effective programs. EFFICIENT OPERATIONS/ Agencies should provide services at a cost that achieves SERVICES ongoing efficiency gains. Public services should be accessible to citizens and responsive to their needs and should be provided in a fair, courteous manner agencies should be operated in ways that give managers incentives to be efficient in using human and financial resources.

INSTITUTIONS FOR SUSTAINABLE FISCAL DISCIPLINE RULES Limits on total spending are set before sectoral spending bids are considered. Total spending must be consistent with these limits. The limits are set for the medium-term (3-5 years) and budget decisions are made within a multiyear framework. ROLES A strong Finance Ministry (or Cabinet Committee) enforces the fiscal aggregates in budget negotiations with spending departments and in cabinet actions. During implementation of the budget, the Finance Ministry may intervene to assure that the fiscal aggregates are maintained. INFORMATION A medium-term expenditure framework (MTEF) provides a baseline for measuring the budgetary impacts of proposed or approved policy changes. During implementation, actual spending is monitored to assure compliance with the aggregates. INCENTIVES Fiscal Rules and outcomes are transparent, and breaches carry political costs. When they work, the rules are politicians with determination to take stringent measures that uphold the fiscal aggregates.

INSTITUTIONS FOR IMPROVING ALLOCATIVE EFFICIENCY RULES Spending limits are established for each sector or Ministry: Ministers are encouraged to reallocate within these limits. Proposed reallocations must be based on evaluation of programs and/or performance measures. ROLES Government through the cabinet or other organ defines priorities and objectives, and makes sectoral allocations within a medium-term framework. Sectoral ministers have authority to reallocate within their areas of responsibility, subject to review by cabinet or parliament. INFORMATION Ministers and managers generate or review data on the actual or expected effectiveness of programs, as well as on social conditions and outcomes. They also consider information on the future spending impacts of authorized and proposed budget decisions. INCENTIVES Sectoral ministers have broader scope to reallocate within their portfolios, with less risk that doing so would cause them to lose resources.

INSTITUTIONS FOR OPERATIONAL EFFICIENCY RULES Operating costs are cash-limited, but managers have broad discretion in using these resources and in providing services. Operating costs are reduced by a percentage equal to all or a portion of projected efficiency gains. ROLES Managerial responsibility is devolved to managers who have flexibility in organizing operations and delivering services but are accountable for their performance. INFORMATION Outputs are specified in advance and actual outputs are compared to targets. Costs are allocated to the activities responsible for them. Information on financial and organizational performance is published in annual reports and other documents. INCENTIVES Managers can use savings to improve services and may carryover unused operating funds to the next fiscal year. In some cases, a portion of their pay is based on performance.

EFFECTIVE ALLOCATION BASIC ELEMENTS Expenditures should be based on government priorities and on the effectiveness of public programs. The budget system should create conditions and incentives that facilitate reallocation from lesser to higher priorities and from less to more effective programs. BASIC ELEMENTS The capacity and willingness to reallocate Priority-setting process in government Information on program outcomes and effectiveness

IMPEDIMENTS TO EFFECTIVE ALLOCATION In all countries: Protected programs have their own financing and are walled off from the rest of the budget. Ministers and managers log roll to protect their budget shares and programs. Interest groups/citizens lobby to defend existing programs/benefits. When increments are available: Government can respond to new priorities by allocating incremental resources, without reexamining old programs. When the budget is tight: It is politically easier to continue existing programs than to cut them in order to finance program initiatives.

THE INSTITUTIONAL FRAMEWORK FOR EFFECTIVE ALLOCATION Fiscal Constraints Constraints or budget totals must be hard so that government cannot avoid reallocation by spending, taxing, or borrowing more. Medium-Term Framework Constrains budget allocation for 3-5 years ahead and establishes framework within which allocations and reallocations are considered. Strategic Capacity Government establishes realistic priorities/objectives along with policies/programs to implement its strategy. Reallocations Between Sectors Strong leadership at top of government including prime minister, finance minister, or cabinet. Central organs concentrate on strategic matters, and devolve expenditure details to sectoral ministers and program managers. Reallocations Within Sectors Made by sectoral ministers subject to review by government.

INFORMATION FOR EFFECTIVE ALLOCATION Budget Baseline (Forward Estimates) Projections of future revenue and spending assuming no change in current policy; including increases and decreases, previously agreed by government as changes to the baseline, and adjustments for changes in economic conditions. Measurement of Policy Changes Process by which the future budgetary impacts of proposed or agreed policy changes are measured in reference the budget baseline. Program Evaluation Systemic review of program effectiveness and process for feeding evaluations into budget decisions. Outcome Measures Quantitative and (in some cases) qualitative measures of program impacts on society; comparison of planned and actual outcomes.

WHY THE ANNUAL BUDGET IS NOT SUFFICIENT FOR ALLOCATING RESOURCES EFFECTIVELY Budgeting is incremental: each year’s allocations differ only marginally from the previous year’s. The budget looks backward: emerging market and developing countries must look forward to build a more robust future. The budget focuses on short-term issues: it lacks a long-term perspective. The budget is driven by fiscal pressures: it slights program needs.

THE MEDIUM-TERM EXPENDITURE FRAMEWORK (MTEF) Extends the time frame of budgeting from one year to 3-4 years A baseline (forward estimate) projects future expenditure for existing programs Annual budgeting is reorganized to focus on policy initiatives (changes to the baseline) The future cost of policy initiatives is measured to assure they are consistent with the fiscal constraint Some countries divide the annual budget process into two stages: a framework (planning) stage during which the fiscal aggregates are set and sectoral allocations are made; and an estimates stage The MTEF is rolled forward each year by dropping the first year and adding a year at the end

BASIC ELEMENTS OF AN MTEF Explicit fiscal targets (such as total spending or the maximum deficit) for each of the next 3-5 years Baseline (forward) estimates of future expenditure Procedures for proposing policy initiatives in the budget Allocation of a budget margin (positive or negative) to each minister, sector, or portfolio Rules for assuring that policy initiatives and budget requests are consistent with the fiscal targets Rules for updating the baseline estimates

THE MTEF BUDGET CONSTRAINT Should Take account of approved plans Be approved by the Government Be realistic and achievable Be sustainable over the medium-term and beyond Be set before departments submitting spending estimates Be broken down into sectoral constraints (allocations) Be supported by procedures for ensuring that policy changes are consistent with it

ISSUES IN OPERATING AN MTEF How many years should it cover? Should it have a contingency reserve for fiscal “surprises” or future policy changes? Should it be based on current or constant prices? How much spending detail should be included? Should allocations for forward years be “guaranteed”? How should the MTEF deal with fiscal shocks?

MTEF DOES NOT GUARANTEE EFFECTIVE ALLOCATION If MTEF is not used for allocations, it is useless Many countries have an MTEF but do not base budget decisions on it MTEF must become the government’s budget process Some countries have an annual budget plus a separate MTEF MTEF should be used by political leaders to set fiscal policy and spending priorities If MTEF is treated as a technical exercise, politicians will not pay attention to it MTEF should focus budgeting on policy choices If budgeting is used to control the details of spending, MTEF will not be of much value MTEF should be a rolling process: Last year’s decisions should be the starting point If the budget disregards medium-term decisions, MTEF will wither away