Budget Institutions and Fiscal Outcomes Ten years of inquiry on fiscal matters at the Research Department Gabriel Filc Carlos Scartascini Research Fellow Economist* Office of Evaluation and Oversight Inter-American Development Bank * Former Junior Professional at the Research Department ( ) The views and interpretations expressed in this paper are those of the authors and should not be attributed to the Inter American Development Bank, or to any individual acting on its behalf.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Objective Objective To serve as a tribute to the work on Budget Institutions and Fiscal Outcomes RES has engaged in since its creation To serve as a tribute to the work on Budget Institutions and Fiscal Outcomes RES has engaged in since its creation

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Method Method We construct a new index of fiscal rules and budget procedures following the methodology in Alesina, Haussman, Hommes and Stein (1996, 1998), and we test their hypotheses in a sample of Latin American and in a larger sample of developing countries We construct a new index of fiscal rules and budget procedures following the methodology in Alesina, Haussman, Hommes and Stein (1996, 1998), and we test their hypotheses in a sample of Latin American and in a larger sample of developing countries We review the new lines of research RES is promoting and developing jointly with other researchers. Basically, the PMP methodology. We review the new lines of research RES is promoting and developing jointly with other researchers. Basically, the PMP methodology.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES The New Index The New Index Following Alesina, et al (1996, 1998) we construct a new index and several sub-indexes using the OECD/WB(/IDB) Budget Practices and Procedures Survey. Following Alesina, et al (1996, 1998) we construct a new index and several sub-indexes using the OECD/WB(/IDB) Budget Practices and Procedures Survey. The survey includes 359 questions on almost(?) every topic related to budget practices and procedures. Includes information on every stage of the budget process at each one of the branches of government. The survey includes 359 questions on almost(?) every topic related to budget practices and procedures. Includes information on every stage of the budget process at each one of the branches of government. So far, 43 countries have answered the survey, including 11 (12) Latin American countries and 21 developing countries. So far, 43 countries have answered the survey, including 11 (12) Latin American countries and 21 developing countries. We selected 22 questions that provide information on fiscal rules, the degree of hierarchy and transparency of budget procedures. We selected 22 questions that provide information on fiscal rules, the degree of hierarchy and transparency of budget procedures.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES The New Index The New Index Composite index (INDEX) Composite index (INDEX) –Fiscal rules (FISCRULES) Fiscal limits (FISCLIMITS) Fiscal limits (FISCLIMITS) Medium Term Fiscal Frameworks (MTFF) Medium Term Fiscal Frameworks (MTFF) Borrowing limits (BORRCONST) Borrowing limits (BORRCONST) Reserve Funds (RESERVFUND) Reserve Funds (RESERVFUND) –Hierarchical procedures (HIERARCHICAL) Within the Executive Branch (RESTMINS) Within the Executive Branch (RESTMINS) Executive-Legislative relations (RESTLEGS) Executive-Legislative relations (RESTLEGS) Cash management (CASHMANAG) Cash management (CASHMANAG) –Transparent procedures (TRANSPARENCY)

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Insights Insights Fiscal rules: laws and/or regulations which establish ex ante constraints on deficits and/or debt may be conducive to fiscal discipline. Fiscal rules: laws and/or regulations which establish ex ante constraints on deficits and/or debt may be conducive to fiscal discipline. Hierarchical procedures: (in contrast to more “collegial” procedures) tend to reduce the incidence of the commons problem and give primacy in the bargaining over the budget to those agents with political incentives to keep finances under control. Hierarchical procedures: (in contrast to more “collegial” procedures) tend to reduce the incidence of the commons problem and give primacy in the bargaining over the budget to those agents with political incentives to keep finances under control. Transparent procedures: should lead to more fiscal discipline as they could increase the chances of enforcement. Even the most stringent fiscal laws can be circumvented if budget documents are unintelligible and unrelated to the real fiscal situation. Transparent procedures: should lead to more fiscal discipline as they could increase the chances of enforcement. Even the most stringent fiscal laws can be circumvented if budget documents are unintelligible and unrelated to the real fiscal situation.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Hypothesis: Hypothesis: Countries with more stringent fiscal rules, hierarchical budget procedures and more transparent budget processes should present better primary fiscal balances (lower primary deficits). Countries with more stringent fiscal rules, hierarchical budget procedures and more transparent budget processes should present better primary fiscal balances (lower primary deficits).

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Preliminary evidence seems to indicate that a country within the group with high scores would have a more positive primary fiscal balance than a country within the group with low scores. Preliminary evidence seems to indicate that a country within the group with high scores would have a more positive primary fiscal balance than a country within the group with low scores. The following table shows the differences on primary fiscal balances as percentage of GDP between countries with the average high and low scores. The following table shows the differences on primary fiscal balances as percentage of GDP between countries with the average high and low scores. INDEXFiscal RulesHierarchicalTransparency Developing Countries Latin American Countries

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES For the econometric analysis, we run the regressions, based on the Alesina, et al (1998) model, for every country, for the developing countries, and for the sample of Latin American Countries. For the econometric analysis, we run the regressions, based on the Alesina, et al (1998) model, for every country, for the developing countries, and for the sample of Latin American Countries. We use the same control variables: Debt, Trade, Pop>65, and Pop 65, and Pop<15, (+ debt service); and the same dependent variable: general government primary fiscal balances, (+ central) As it can be deduced from the following graphs, the fitness of the regressions is better for the developing and Latin American countries than for the world sample (Maastricht, Monetary Union, etc). As it can be deduced from the following graphs, the fitness of the regressions is better for the developing and Latin American countries than for the world sample (Maastricht, Monetary Union, etc).

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES

Even though recommendations have not been implemented exactly as devised, some budget reforms that took place in the ‘90s did not achieve the expected results. Even though recommendations have not been implemented exactly as devised, some budget reforms that took place in the ‘90s did not achieve the expected results. The lack of success of some of these reforms could be blamed on the policies themselves, but in other cases, the recommendations have not taken into account the specific characteristics of the countries. The lack of success of some of these reforms could be blamed on the policies themselves, but in other cases, the recommendations have not taken into account the specific characteristics of the countries. Studies aiming to understand the budget process and to render successful recommendations should not only consider the existence or not of certain fiscal rules and budget procedures but most importantly, to consider the incentives of managers of public monies to comply with budget rules and procedures, and the overall policymaking process in which the acceptance and compliance with rules and procedures is embedded. Studies aiming to understand the budget process and to render successful recommendations should not only consider the existence or not of certain fiscal rules and budget procedures but most importantly, to consider the incentives of managers of public monies to comply with budget rules and procedures, and the overall policymaking process in which the acceptance and compliance with rules and procedures is embedded.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES The “lenses” provided by the “PMP methodology” (as explained by Spiller, Stein, and Tommasi (2003)) and the “BMP” (its application to the analysis of the budget process) forces the analyst to understand the transaction environment behind the budget process and to comprehend the actions of the agents in charge of budgetary decisions according to their incentives, incentives that are affected by the political institutions of each country. The “lenses” provided by the “PMP methodology” (as explained by Spiller, Stein, and Tommasi (2003)) and the “BMP” (its application to the analysis of the budget process) forces the analyst to understand the transaction environment behind the budget process and to comprehend the actions of the agents in charge of budgetary decisions according to their incentives, incentives that are affected by the political institutions of each country. Under this methodology, public expenditures are the outcome of complex intertemporal exchanges among political actors that participate in the budget process. Under this methodology, public expenditures are the outcome of complex intertemporal exchanges among political actors that participate in the budget process.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Using these “lenses”, we could evaluate whether traditional and generally pertinent recommendations are useful to solve fiscal challenges when applied to countries with different features of the policymaking process. Using these “lenses”, we could evaluate whether traditional and generally pertinent recommendations are useful to solve fiscal challenges when applied to countries with different features of the policymaking process. The paper presents some case studies, that show that very reasonable reforms like increasing transparency, reducing the discretionary funds of legislators, and reducing the discretion of the executive branch for cash managing expenditures, recommendations usually proposed for Latin America, could have unintended effects, potentially worsening the reality they are designed to improve because of the policy environment in which they are inserted. The paper presents some case studies, that show that very reasonable reforms like increasing transparency, reducing the discretionary funds of legislators, and reducing the discretion of the executive branch for cash managing expenditures, recommendations usually proposed for Latin America, could have unintended effects, potentially worsening the reality they are designed to improve because of the policy environment in which they are inserted. Examples: Cash-management in Brazil, “auxilios parlamentarios” in Colombia, transparency and roll call votes in Paraguay, and the Copper Stabilization Fund in Chile. Examples: Cash-management in Brazil, “auxilios parlamentarios” in Colombia, transparency and roll call votes in Paraguay, and the Copper Stabilization Fund in Chile.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Reducing the discretionary power of the Executive. The case of cash-management in Brazil.* POLIT. INSTIT. AND POLIT. TRANSACTIONS PROPOSED REFORMOBJECTIVEUNINTENDED CONSEQUENCES (?) POLIT. INSTITUTIONS: Presidential system. Open lists electoral system. Fragmented Party System. Low party powers of the President (lacks control of candidate selection). GAME OF POL. TRANS: The President has to negotiate key votes with legislators using the inclusion of “pet” projects in the budget as political currency. To curtail the discretion of the president to selectively choose which projects to execute and when, and which projects to cut, allowing only cuts across the board. To increase the predictability and the efficiency of government expenditures. Increased difficulty to achieve political agreements. More expensive negotiations of the president with other political actors could affect fiscal balance. * See Alston, et al (2004)

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Summary Summary Following previous work by RES, we constructed a new index of fiscal rules and budget procedures and several subindexes. Following previous work by RES, we constructed a new index of fiscal rules and budget procedures and several subindexes. Empirical results indicate that countries with more stringent fiscal rules, and especially with more hierarchical budget procedures seem to present better primary fiscal balances (lower primary deficits). Empirical results indicate that countries with more stringent fiscal rules, and especially with more hierarchical budget procedures seem to present better primary fiscal balances (lower primary deficits). Among the components of fiscal rules: the use of medium term fiscal frameworks. Among the components of fiscal rules: the use of medium term fiscal frameworks. Among the components of hierarchical procedures: the capacity of the executive to cash-manage expenditures, restrictions on the legislature, and restrictions on the bargaining within the executive branch. Among the components of hierarchical procedures: the capacity of the executive to cash-manage expenditures, restrictions on the legislature, and restrictions on the bargaining within the executive branch.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Summary Summary Reforms on budget procedures and the introduction of certain fiscal rules have not achieved the expected results. Reforms on budget procedures and the introduction of certain fiscal rules have not achieved the expected results. Given the state of disenchantment of the population in Latin America, it is peremptory that policy researchers suggest those recommendations with the highest probability of success. Given the state of disenchantment of the population in Latin America, it is peremptory that policy researchers suggest those recommendations with the highest probability of success.

Budget Institutions and Fiscal Outcomes. Ten years of inquiry on fiscal matters at RES Summary Summary Because the success of policy reforms depend on the characteristics of the policy environment in which they are inserted, in-depth knowledge of the policymaking process is needed. Because the success of policy reforms depend on the characteristics of the policy environment in which they are inserted, in-depth knowledge of the policymaking process is needed. The “lenses” suggested in the PMP and the BMP methodology could help on this regard. The “lenses” suggested in the PMP and the BMP methodology could help on this regard.