Public Finance Analysis and Management: An Overview

1
Public Finance Analysis and Management An
Overview

• Anand Rajaram, PRMPS
• PFAM Course
• PREM Learning Week 2007
• April 23, 2007

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Outline

• Public Economics and Public Finance Theory
• Some Empirical Observations
• The Evolution of Bank work on Public Finance
• the link to lending and CAS
• From policy to management
• Response to fiduciary concerns
• Measuring PFM performance
• The Current State of Play
• Future Directions

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1. Economics of the Public Sector

• Mercantilist view govt. promotion of trade and
  industry (colonies)
• Adam Smith invisible hand guides markets to
  provide goods and services, competition weeds out
  inefficiency
• Subsequent recognition of market failures-
  barriers to entry/exit, public goods,
  externalities, incomplete markets, information
  and coordination problems, macro-disequilibrium
  (Stiglitz)

4
Adam Smith on the Role of the State

• The three duties of the sovereign
• protecting society from the violence and invasion
  of other societies by maintaining a standing
  armed force
• protecting every member of society from injustice
  or oppression by others by establishing an
  exact administration of justice
• erecting and maintaining those public
  institutions and public works which, though they
  may be in the highest degree advantageous to a
  great society ..the profit could never repay the
  expense of any individual or small number of
  individuals .. to erect or maintain.
• chiefly for facilitating commerce (roads,
  bridges, canals, harbours, etc.) and for
  promoting education
• So Smith anticipated public goods but not other
  forms of market failure (externalities,
  incomplete markets, etc.)
• No mention of social protection or transfers

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Role of Modern Government

• To use regulation, taxation and public
  provision/financing to correct for market
  failures, improving the efficiency of the economy
  and overall growth
• To use public policy instruments to improve
  equity and protect the vulnerable
• Need to take into account the scope for
  government failure
• Political and economic ideology determines size
  and scope for government (ISI, welfare state,
  urbanization, health pandemics, regional
  conflicts, ODA)

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The Theory of Public Finance

• Government functions allocation, distribution
  and stabilization (Musgrave)
• Revenue is needed to finance public goods and
  services, to redistribute income, and to regulate
  macroeconomic balances
• Raising revenue is not costless disincentive
  effects of taxation and administrative costs of
  collection
• Efficiency requires taxing goods that are
  inelastic, tax consumption rather than labor or
  capital, use broad based taxes
• Debt is a form of deferred revenue raising
  (Ricardian equivalence)

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Public spending

• Theory offers some general principles for
  expenditure policy
• Public expenditure is inefficient if it crowds
  out private expenditure
• Some kinds of goods and services would be welfare
  and growth enhancing those that markets fail
  to produce
• Equity can be enhanced by public provision of gs
  to the poor or other target groups

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2. Some Empirical Observations
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Growth of Government a relatively recent
phenomenon
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Revenue and Expenditure Vary With Income( of
GDP, 2002)
Total Revenue Total Expenditure Total Expenditure
Income Level GG GG CG
Low Income 25.3 30.3 20.5
Lower Middle-Income 30.0 28.9 28.8
Upper Middle-Income 30.4 33.9 28.6
High Income 39.9 39.7 26.6
Note Cash basis GGGeneral Government CGCentral
Government
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Across Countries Financing Sources also vary
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Aid Sustains Spending in some regions (In
Percent of GNI)
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Public spending and sector outcomes are often
weakly related (WDR 2004)
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Missing variables

• Intuitively, differences in policies and
  institutions could explain the weak
  expenditure-outcome link across countries
• WDR 2004 identified some core elements
• Budget policy and management
• Organization of tiers of government
• Quality of public administration
• Other factors role of private sector

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Typical budget pathologies in LICs

• Overambitious development plans, unclear policies
• Unrealistic budgets
• No disciplined link between policy, plan and
  budget
• Incremental budgeting, no forward perspective
• Non-transparency - extra-budgetary funds, lack
  of comprehensive budget framework
• Budget execution marred by unpredictable
  allocations, including interruptions in flow of
  funds
• Symptoms of problems arrears in payments to
  suppliers, unpaid bills to utilities, incomplete
  projects, lack of maintenance of assets, poor
  services
• Tax evasion

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3. Evolution of Bank PER work

• In the 1980s, focus limited to investment budget
  identifying white elephants
• With SAL and budget support, broader concern for
  overall budget in the 1990s
• By late-90s, growing focus on PEM and reduced
  focus on policy
• Early 2000s, fiduciary concerns and development
  of CFAAs and CPARs and HIPC expenditure tracking
  indicators
• Sub-national public finance work in large
  countries (India, Indonesia, China, Brazil)

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Role of the PER

• The PER provides Bank management and Board with a
  view on the quality of budget policy and
  management in a country
• Used to determine if budget support is
  appropriate
• Whether policies are sustainable or efficient
• Whether the budget is aligned with policy
  objectives
• Whether budgetary processes support effective
  implementation and policy outcomes
• To advise the government on options for reform of
  policy and/or management
• To support government in designing and
  implementing reform and building capacity

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Scope of PERs

• Typical PER - a brief discussion of overall macro
  (trends in growth, inflation, revenue and
  deficits)
• Reference, perhaps, to an IMF-determined fiscal
  framework with medium term aggregate deficit,
  revenue and expenditure targets
• So, fiscal (deficit) policy is given by IMF
  program
• PER may then turn to discussion of sector
  expenditures and/or budget formulation and
  execution, MTEF, etc.
• No strong links established in many PERs between
  budgets and growth objectives
• No true long term perspective to guide fiscal
  policy

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PERs Differ in Coverage and Approach

• In general, recent PERs expected to cover more
  issues
• Relative emphasis on policy or management or
  special topics may differ across PERs
• Differences also in degree of participation by
  government counterparts
• Different approaches to integrating with related
  products CFAA and CPAR
• PERs beginning to take the form, not of a single
  report, but a sequence of complementary
  analytical modules to support government reforms

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Examples of PERs varied formats

• PIR as a supplement to Customized BM report
  Russia
• The PEM and the PEP Mozambique (2001), (2003)
• PE Reform support to MTEF Albania (2001)
• Bank supplement to Govt PER Malawi, Tanzania,
  Zambia
• PEIRs Turkey, Macedonia, Croatia, Bosnia
• Annual PERs with regional supplement Ethiopia
  (2001)
• Annual PE process report Uganda
• PERs w/Intergovt.Fiscal Czech,Thailand,
  Kazakh,Bosnia
• Provincial PERs Punjab (Pakistan), Maharashtra
  (India)
• Indonesia, China
• Integrated PEM reports Philippines, Iran, Zambia

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PER coverage, 1999-2003
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Have Bank-Fund roles been effective?

• Fund leads on stabilization issues and forms
  view on aggregate fiscal stance
• Fund has greater capacity on revenue policy and
  administration while Bank does finance tax admin.
  projects
• Bank leads on allocative and distributive
  issues w.r.t. budgets
• Both IFIs provide advice on PEM
• But this form of collaboration has its
  limitations and does not serve clients well

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4. Current State of Play

• In recent years, governments have complained
  about fiscal policy demand for fiscal space for
  growth
• IMF papers on public investment and fiscal policy
  concluded that changes in fiscal rules would be
  risky and unwarranted
• Bank asked to provide a developmental perspective
  on fiscal policy and scope to better support
  growth
• Two papers to Dev. Committee lays out our view

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5. Future Directions

• PRMVP speech underlined importance of fiscal work
• Bank will adopt a public finance perspective,
  encompassing revenue, aid, debt and expenditure
• New growth diagnostics approach (Rodrik,
  Hausmann) provides basis to link public
  expenditure and fiscal policy to growth
• Efficiency analysis and incidence work at the
  sector level will be key to improving advice to
  governments including exciting new experimental
  approaches at MIT poverty lab

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Annex

• Join the Public Finance thematic group to hear
  about BBLs and to have access to a community of
  practitioners
• Visit Public Finance website at
• http//web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EX
  TPUBLICSECTORANDGOVERNANCE/EXTPUBLICFINANCE/0,,men
  uPK1339576pagePK149018piPK149093theSitePK13
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