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MANAGING PUBLIC EXPENDITURE Objectives and
Approaches
    Flagship Course on Governance and
Anticorruption   December 1, 2003   Allen
Schick  
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How Public Expenditure ManagementDiffers from
Conventional Budgeting

•  
• Conventional budgeting emphasizes procedures PEM
  focuses on outcomes
• Conventional budgeting assumes that policymakers
  are rational PEM argues that they act on the
  basis of incentives
• Conventional budgeting often results in big
  deficits PEM demands fiscal discipline
• Conventional budgeting often results in frozen
  priorities PEM enlarges governments capacity to
  allocate resources on the basis of new priorities
• Conventional budgeting often results in
  inefficient operations PEM encourages efficient
  provision of services

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Basic Elements of Effective Government Budgeting

• Fiscal Discipline - Budget totals should be the
  result of explicit, enforced decisions. They
  should not merely accommodate spending demands.
  These totals should be set before spending
  decisions are made, should be enforced during
  implementation of budget, and should be
  sustainable over the medium term and beyond.
• Allocative Efficiency Expenditure decisions
  should be based on government priorities and on
  evidence concerning the effectiveness of public
  programs. The budget system should facilitate
  reallocation from lesser to higher priorities and
  from less to more effective programs.
• Operational Efficiency Agencies should provide
  goods and services at a cost that achieves
  ongoing efficiency gains. These services should
  be accessible to citizens and responsive to their
  needs and should be provided in a fair and
  courteous manner.

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RULESLimits on total spending (and, in some
cases on sectoral spending) are established
before individual spending bids are considered.
Total spending must be consistent with these
limits. The limits may be expressed in a variety
of ways in money terms, relative of GDP, as
rates of change, or in terms of the balance
between revenues and expenditures. The limits are
set for the medium-term (3-5 years) and budget
decisions are made within this medium-term
framework.
Institutional Arrangements for Enforcing
Aggregate Fiscal Discipline
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Alternative roles for Fiscal discipline
Advantages/Disadvantages
Balanced budget In any fiscal year, spending shall not exceed revenue. This rule constrains Government and the Legislature and provides a reasonably simple basis for monitoring compliance. But it is rigid and does not accommodate changes in economic conditions. It cannot be achieved when they economy is depressed.
Dynamic fiscal policy Fiscal totals should be set each year for (and adjusted as necessary) to stabilize the economy at a level that results in low inflation and high employment. This rule recognized the Governments responsibility managing the economy and improve the well-being of citizens. But the rule is politically difficult to maintain because it is easier to raise demand than to contract it. Over time, this rule leads to growth in the size of the public sector and higher tax burdens.
Enforced fiscal targets Targets are set by Government and the legislature before revenue and spending decisions are made. These targets may require a balanced budget or permit a deficit. Targets are explicitly fixed in advance. They do not merely accommodate political demands or automatically fluctuate with changes in economic conditions. The main problem is that few governments have been successful in enforcing targets over the long term through changes in economic conditions.
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Institutional Arrangements for Enforcing
Aggregate Fiscal Discipline
ROLES A strong finance ministry enforces the
budget aggregates in cabinet decisions and
bilateral negotiations with spending departments.
The finance ministry measures the budgetary
impact of spending proposals and of other actions
affecting the totals, and advises the government
on the status of the budget. During
implementation of the budget, the Finance
Ministry may intervene to block (or notify the
government) of actions that would cause the
fiscal aggregates to be breached.
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Factors that Undermine fiscal discipline
INFORMATION The medium-term expenditure framework
establishes a baseline for measuring the
budgetary impact of proposed or adopted policy
changes. Throughout formulation of the budget,
information is provided on deviations from the
baseline due to new policies, changes in economic
conditions, or re-estimates of existing programs.
During implementation, spending is monitored to
ensure compliance with the fiscal aggregates.
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Factors That Undermine Fiscal Discipline
FACTOR DISCUSSION
Unrealistic Constraints When totals are selected for political reasons, without regard to their achievability, they may weaken fiscal discipline.
Unrealistic Budgets Some governments (especially in poor countries) adopt budgets that that purport to show fiscal discipline but have little to no possibility of being implemented.
Entitlements When citizens have a legal right to payments from the government regardless of budget conditions, it may be difficult to stay within fiscal targets.
Contingent Liabilities The cost of contingent liabilities often is underestimated when the government accepts the risk (such as guaranteeing loans or the performance of enterprises). When the cost comes due (because of default or other contingency) it is not controllable through ordinary budget means.
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Practices that Strengthen Fiscal Discipline

• Targets should reflect political commitments made
  by government leaders.
• Targets must be realistic and achievable.
• Targets should be set and enforced within a
  medium-term fiscal framework.
• Limits on aggregates should be supported by
  sub-targets on sector/portfolios.
• Fiscal constraints should cover mandatory
  spending.
• Government should publish audited financial
  statements on fiscal condition.

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Institutional Arrangements for Improving
Allocative Efficiency
Rules Spending limits are established for sectors or portfolios, and ministers are encouraged to reallocate within these limits. Bids to reallocate must be based on evaluation of program effectiveness or on outcome measures.
Roles Strong capacity at center of government to define national priorities and objectives, and make sectoral allocations consistent with the medium-term expenditure framework. Sectoral ministers have broad authority to reallocate within their areas of responsibility, subject to review by Cabinet and/or Parliament.
Information Ministers and managers generate or receive information on the actual or expected effectiveness of programs, as well as on social outcomes. They also receive information on the expenditure impacts (relative to the medium-term baseline) of authorized and proposed budget actions.
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The Institutional Framework for Reallocation
Fiscal Constraints Constraints must be
sufficiently effective so that government cannot
avoid reallocation by spending, taxing, or
borrowing more. . Medium-Term Framework Constrain
ts 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.
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Tools for Improving Allocative Efficiency
STRATEGIC PLANNING Sets government objectives
and priorities MEDIUM-TERM FISCAL FRAMEWORK Sets
budget constraints for allocating
resources PROGRAM BUDGETING Allocates resources
in accord with priorities PROGRAM
EVALUATION Assesses impact of programs on public
objectives OUTCOME MEASURES Measures the
effectiveness of programs and activities
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Institutional Arrangements for Improving
Operational Efficiency
RULES Running (operating) costs are cash limited, but managers are given broad discretion in using these resources. These costs are progressively reduced by a percentage equal to all or a portion of expected efficiency gains.
ROLES Line managers determine the use of operating resources within fixed limits. Operating discretion is devolved to subordinate managers, in field or regional offices.
INFORMATION Outputs are specified in advance, and actual outputs are compared to the targets. Costs are allocated to the activities responsible for them. Information on financial and organizational performance is published in annual reports and other documents.
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Innovations for Improving Operational Efficiency
INNOVATION EXPECTED IMPROVEMENT
Running Cost Budget Managers are given a single allocation for all operating expenses, thereby reducing compliance costs and enabling them to operate efficiently
Devolved Budgets Line and field managers have their own operating budgets and are able to adjust to local needs and conditions
Efficiency Dividend Percentage reduction in running cost budgets equal to expected productivity gains impel managers to seek efficiency improvements
Output Targets Managers have advance notice of expected performance, thereby enabling government to hold them accountable for cost and outputs
Out-Sourcing Enables government to select more efficient producers by privatizing or out-sourcing the production or delivery of services
Performance Agreements Formal contracts between purchasers and producers specify resources to be provided and outputs to be produced
Annual Reports and Audits Compare actual and contracted (or targeted) financial and operating results, with independent review to access accuracy of reported results
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Factors that Degrade Operational Efficiency
Perverse incentives Spenders have incentive to
use all the resources provided them if they
dont, they risk cuts in the next
budget Information asymmetry Service providers
know more about outputs and costs than do those
who allocate resources To get more money,
providers manipulate or withhold information from
superiors Rigidity Managers have no opportunity
to use their skills and information to improve
efficiency Compliance costs Detailed, ex ante
controls are costly and drive out initiative and
variation Budget maximizing behavior Inasmuch as
government must pay whatever it costs to operate
its programs, inefficient producers are rewarded
with bigger budgets Capture Government is
captured by service providers it lacks
independent information on performance and must
purchase services from them