1. BOSNIA AND HERZEGOVINA
Public Expenditure Reforms in BIH:
Moving from Aid Dependency
to Fiscal Self-Reliance
World Bank
March 4, 2003

2. Outline of the Presentation
The case for expenditure rationalization
Salient features of public expenditure in BIH from four points of analysis:
What? Where? Who? How?
Some suggested priorities for reforms

3. Macroeconomic achievements
Robust post-conflict economic growth performance (25% p.a.between )
Anchors of macroeconomic stability: the currency board and recent fiscal stabilization…
… resulting in low inflation and confidence in the domestic currency
Some progress in structural and administrative reforms: financial sector, tax administration, expenditure management

4. Outstanding macroeconomic challenges
Although still positive, economic growth has been rapidly fading
Export performance remains subdued, resulting in an important current account gap (about 20 % of GDP)
Employment growth remains subdued
Pace of structural reforms directly aimed at stimulating supply responses of the economy has been uneven and altogether slow (privatization, business environment, public sector and corporate governance, rule of law)

5. The macroeconomic case for fiscal adjustment

6. Is public spending too high in BIH?
Current size of public expenditure is beyond sustainability:
Realistic (and desirable) resource availability
Transition to private-sector led growth
Comparison with size of Government in other transition economies (above 55% in BIH vs. 35%-40% in most first-tier accession countries and below 30% in OECD)
Recurrent accumulation of arrears (esp. at the local level) suggests that current size is not affordable

7. Constraints to expenditure rationalization
Additional pressures on public finances are likely in the period ahead:
Unpredictability of the decline of aid flows
Need to alleviate tax burden on the economy
New expenditure pressure points: institution/ capacity-building, possible adjustment costs after public sector downsizing, public investment needs,…
Fiscal risk: contingent liabilities, quasi-fiscal operations, deferred deficits (esp. at the local level)
Rigidities in expenditure and complex intergovernmental arrangements

8. Salient Features of Public Expenditures:
1. On what are resources spent?

9. Public Sector Spending in Wages and Salaries
Public sector spending on Wages and & Salaries (W&S) is
disproportionately high in BiH
Public Sector Spending in Wages and Salaries
Sources: Official data & staff estimates for BiH; WB data sources.
Source: Official data & staff estimates for BiH; WB data sources.

10. Tensions in recurrent spending
Wages and salaries crowd out spending on operations and maintenance:
Ratio of wage to non-wage spending is high in BIH, particularly in the FBIH:

11. Salient Features of Public Expenditures: 2. Where do the resources go?

12. Defense expenditure remains large
Spending on defense is above average, although recent demobilization should bring it down by about 1-1.5% of GDP
Within the defense sector, the weight of W&S is particularly disproportionate (between 70% and 80%, NATO average: 40%)
Further rationalization of spending and improvements in reporting and financial discipline
Spending on public order and safety appears equally large. Urgent need to undertake sectoral expenditure review.

13. Social Transfers
BIH has, on aggregate, an extensive transfer program with one of the most generous benefit system for war veterans in Europe (3-4% of GDP): urgent need to tightly define entitlements
The short-term agenda for pensions: maintain financial stability while improving collection performance
Outside veteran benefits and social security, social protection benefits are very low
As a consequence, the transfer system appears to be regressive with the most needy being left out or insufficiently targeted

14. Social expenditures Education spending is high and inefficient:
High unit costs and low student-teacher ratios (esp. vocational, tertiary);
Fragmented provision of higher education
Input-based financing carries wrong incentives
Low allocative efficiency: poverty incidence among vocational training graduates, low enrollment in general secondary
Wide disparities in per pupil spending leads to access inequality of education
Complex intergovernmental assignments disrupt service provision at the local level

15. Social expenditures (cont.)
Health care financing remains fragile:
First wave of reforms successful in establishing relatively stable, although very fragile, health insurance funds; pooling of catastrophic risk in the Federation
Fundamental problem of mismatch between entitlements and collected resources remains acute leading to high (and regressive) out-of-pocket financing and unregulated private sector delivery
High burden on payroll taxation characterized by poor enforcement of collection , numerous exemptions, and unreliable financing for disadvantaged groups (pensioners, unemployed, self-employed, refugees, IDPs)
Network of providers is marked by fragmentation, overlap, mismatch between services provided and needs, and soft budget constraints
System bias against preventive and primary health care

16. Salient Features of Public Expenditures: 3. Who spends the resources?
Significant vertical fiscal pressures on the State and the municipalities because of their very limited own revenues as a source for financing their current responsibilities—e.g. in 2001 the State’s own revenues could cover less than 30% of its operational expenditures, and in 2000 the municipalities’ estimated own revenues could cover only about one-quarter of their expenditures in both Entities
Significant horizontal fiscal pressures in both Entities because present large revenue disparities at the sub-Entity level severely impeding low activity location’s service capacity and/or risk potentially larger fiscal imbalances

17. Key issues in fiscal decentralization
Define the role of the State (including its revenue base) in the context of institution building, economies of scale, and regulatory harmonization
Revenue and expenditure assignments: putting order in the “house” with the equitable delivery of quality public services as the ultimate objective
Vertical / horizontal policy coordination
(1) Stress regulatory function in the view of the SES: environmental standards, CRA, Power RA, SBS, Customs, VAT (Admin., Structure,…), quality standards (e.g. education), policy coordination/monitoring (e.g. data consolidation needs).
(2) Address vertical/horizontal imbalances,
(3) Fiscal self-reliance is not only financial, it also implies self-reliance on the formulation and implementation of coherent budget policies in the country (consistency of legislations, policy coherence, conflict resolution, accountability)

18. Salient Features of Public Expenditures:
4. How are the resources managed?
Strategic programming and budget preparation: episodic initiatives remain to be institutionalized
Budget execution and reporting: progress on
treasury system, FMIS, recording, accounting
Public procurement needs major reform
Internal controls & audits: redefine their role in the expenditure cycle
Supreme audit institutions and external oversight: promising first steps but lack of follow-up
Rules of transparency and integrity yet to be enforced

19. Conclusion: the triple challenge
of expenditure reform
1. Rationalization of total public expenditure as to decrease its share in the economy: no other alternative to accommodate financially sustainable, private sector-led growth
2. Increased efficiency and equity of expenditure so that it can have an impact even within the hard budget constraint
3. Transparency and good governance in the management of public resources with a view to raise its efficiency but also to regain trust of taxpayers, beneficiaries, financiers, entrepreneurs and investors

20. Some suggested priorities for reforms
Strategically manage expenditure rationalization rather than be subjected to it  critical need to complete strategic budgeting process (PRSP/MTEF)
Institutionalize fiscal policy coordination: State/Entities, Entities/Sub-entity
Address the issue of civil service reform and wage bill containment
Further rationalize excessive spending (defense, veteran benefits)

21. Some suggested priorities for reforms
In core public services, restructure expenditure to realize efficiency gains under an assumption of overall spending freeze
Intensify policy debate on intergovernmental fiscal relations
Limit and manage fiscal risk: eliminate soft spots in the budget constraint, strictly adhere to financial stability principles for extra-budgetary funds,…
Establish track record in strengthening fiduciary framework (e.g. public procurement) and governance (e.g conflicts of interest, anti-corruption)