The International Handbook of Public Financial Management

Richard Allen, Richard Hemming, B. Potter, Richard Allen, Richard Hemming, B. Potter

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137315304
• Topic: Business
• Subtopic: Financial Services
• Index: Business

The Handbook is a virtual encyclopedia of public financial management, written by topmost experts, many with a background in the IMF and World Bank. It provides the first comprehensive guide to the subject that has been published in more than ten years. The book is aimed at a broad audience of academics/students, government officials, development agencies and practitioners. It covers both bread-and-butter topics such as the macroeconomic and legal framework for budgeting, budget preparation and execution, procurement, accounting, reporting, audit and oversight, as well as specialist subjects such as government payroll systems, local government finance, fiscal transparency, the management of fiscal risks, sovereign wealth funds, the management of state-owned enterprises, and political economy aspects of budgeting. The book sets out numerous examples and case studies describing good practice in public financial management, and is highly relevant for use in both advanced and developing countries.

Part I

The Institutional and Legal Framework

Introduction

The first part of this book comprises seven chapters that set out the institutional and legal foundations of PFM. The first foundation is the relationship between PFM and the macroeconomic framework for managing public finances. PFM can be thought of as the systems and processes that are necessary to make effective use of the government’s macroeconomic policies; for example, to achieve sustainable fiscal outcomes or to implement a numerical fiscal rule such as a specified ratio of government borrowing or debt to GDP. Second, effective PFM systems need to be underpinned by a coherent framework of constitutional provisions, laws and regulations defining which budgetary processes are important, who is responsible for implementing them and when key decisions should be taken. Third, the concept of fiscal institutions – as defined by the laws, regulations and other rules, formal and informal, that govern the behavior of actors in the budget process – is a basic building block of PFM, and issues relating to the “political economy” of budgeting and public finance need to be both analyzed and factored into strategies and programs for strengthening PFM. The fourth foundation concerns the role, responsibilities and organizational structure of the “central finance agency”, while the fifth concerns the role and responsibilities of the legislature, which plays an important role in the decision-making process on public finance and in scrutinizing proposals made by the executive branch of government. Part I concludes with an assessment of how the quality of PFM systems can be evaluated and how these systems have evolved over time.

Chapter 1, by Richard Hemming, focuses on the macroeconomic underpinnings of PFM; namely, how fiscal policy affects macroeconomic outcomes and how macroeconomic considerations influence fiscal policy choices. Traditional macrofiscal topics – the macroeconomic consequence of fiscal deficits, debt sustainability, fiscal targeting and adjustment, countercyclical fiscal policy, approaches to promoting fiscal discipline – are discussed and the interactions between these topics and PFM explained. The linkages between fiscal policy objectives and PFM requirements are set out. PFM practitioners need to be aware of these interactions so that PFM can be placed in its proper macroeconomic and fiscal policy context. Fiscal policy and PFM are two sides of the same coin, the first being concerned with how policies should be designed to achieve certain fiscal objectives; the second with how such policies should be implemented.

Chapter 2, by Ana Corbacho and Teresa Ter-Minassian, provides a specific example of the analysis set out in Chapter 1; namely, the PFM requirements for the effective implementation of numerical fiscal rules. Well-designed and effectively implemented fiscal rules may increase the predictability of fiscal policy by helping contain deficit bias, reducing the time inconsistency of budgetary policies, strengthening the credibility of a government’s commitment to fiscal sustainability, and facilitating countercyclical fiscal management. Good design and effective implementation, however, can be challenging goals and need to be assessed together. A perfectly designed fiscal rule that cannot be successfully implemented within the existing PFM institutions can quickly lose relevance and credibility. In turn, the effective implementation of a poorly designed rule will not deliver its fiscal objectives and may even be counterproductive for sound fiscal policy. The chapter highlights core PFM characteristics that need to be in place before the adoption of fiscal rules. It also discusses trade-offs in design and hence in the objectives that fiscal rules can aspire to, building on the literature of fiscal rules and PFM, together with the experience of a wide range of countries at varying levels of income and capacity.

Chapter 3, by Ian Lienert, discusses the legal framework that underlies the public finance system, including tax laws, budget system laws (BSLs), and local government finance laws. The primary focus of the chapter, however, is on the laws related to the national budget system and to fiscal responsibility. A BSL is the formal expression of the rules that govern budgetary processes and decision making of the legislature and the executive. The objectives of these rules are to specify which budgetary processes are important, who is responsible for exercising authority on the main decisions and operation responsibilities and when key budgetary steps should be undertaken. The question of how budget processes are implemented is sometimes addressed in the primary law, sometimes in secondary regulations or government decrees. The legal basis for public finance varies enormously across countries. At one extreme, a few countries do not have a BSL apart from a constitution. At the other extreme, there are countries, such as the United States, that have many laws related to the federal budget system. The chapter considers the basic principles that constitute a well-designed BSL. It also examines areas of PFM that could be included in a BSL or a fiscal responsibility law.

Chapter 4, by Joachim Wehner and Paolo de Renzio, addresses an issue of growing importance in the literature – the “political economy” of budgeting – that has become ubiquitous in policy debates on PFM. Government budgets give expression to fundamental trade-offs determined by political actors with competing claims on scarce resources. In budgeting, therefore, politics and economics are inherently intertwined. The chapter reviews several main strands of the literature; namely, those that provide a political economy perspective on the study of budgeting, with a particular focus on the design of fiscal institutions. It also highlights some important trade-offs that need to be kept in mind when designing fiscal institutions and the limitations of current approaches to PFM reform, with a particular focus on developing countries. The chapter offers some guidance for practitioners and policymakers and suggests some interesting areas for further research.

Chapter 5, by Richard Allen and Philipp Krause, reviews the role, responsibilities and organizational structure of the central finance agency (CFA), which may be defined as the group of government ministries and agencies – notably, the ministry of finance – that is responsible for developing policy on and implementing the national budget and other core finance functions of the state. Debate on financial issues determines the shape and course of economic development and the viability and performance of all institutions, whether in the private sector or the public sector. Financial crises occur frequently, and it is no coincidence that on such occasions the CFA is at the centre of the political debate. The chapter argues that the effectiveness of a CFA – namely, its structure, internal management and business processes, as well as its relationship with other key players such as the central bank, the council of ministers, line ministries and the legislature – is of crucial importance to strengthening PFM. It discusses how CFAs have evolved from royal purse holders in pre-modern times to the complex, multidimensional organizations familiar today. The chapter draws some conclusions on how CFAs can be strengthened in countries at varying stages of development. In advanced countries, CFAs have developed more streamlined and flatter organizational structures, stronger communication networks (both internal and external), devolved decision-making, and highly-tuned strategies for managing human resources and IT systems.

Chapter 6, by Ian Lienert, argues that the active engagement of the legislature in the budget process is usually considered to be an essential part of democracy. If the legislature is bypassed or is inactive in budget decision making, fiscal policies are decided by government politicians on the advice of unelected officials. In the absence of strong accountability mechanisms on the government, there is a risk that budgetary policies become determined by the wishes of unelected elites. However, the impact of the legislature on budget and fiscal policy outcomes varies widely from country to country and is not necessarily beneficial. Members of the legislature are also politicians and have a short-term horizon when deciding fiscal policies. The legislature’s interests may be focused on maximizing budget spending in constituencies. Both factors can result in deficit bias. This common pool resource problem, observed first at the budget formulation stage within the executive, may be even stronger at the parliamentary approval stage. In countries where the legislature has unrestrained budget amendment authority, it is prone to introduce changes that increase spending or reduce revenues, thereby worsening the overall fiscal position. The chapter discusses the rules and procedures of the legislature in relation to the budget and fiscal policy, and how legislatures might be helped to build the capacity required to exercise their role more effectively.

Chapter 7, by Paolo de Renzio, explains how government budgets have developed over the past 300 years as sophisticated systems for managing public resources. As national budgets and government’s financial relationships have become larger and more complex, the design of effective budget systems has coalesced around a set of widely accepted principles such as comprehensiveness, unity, annuality, and clarity. The chapter discusses past attempts at defining PFM systems and their quality, highlighting their shortcomings. It reviews the potential challenges of comparing budget systems across countries and over time. Finally, it considers how the quality of PFM systems can be operationalized and measured and provides an overview and critical assessment of existing methods and data sources, such as the Public Expenditure and Financial Accountability (PEFA) framework.

1

The Macroeconomic Framework for Managing Public Finances

Richard Hemming

This chapter is about the macroeconomic analysis of fiscal policy, or macrofiscal analysis, which is concerned with how fiscal policy affects macroeconomic outcomes and how macroeconomic considerations influence fiscal policy choices. Much that is written about this subject may seem somewhat divorced from what most PFM practitioners do in their everyday work, be it as PFM advisors or government officials with PFM responsibilities. However, while the core of this chapter is about traditional macrofiscal topics – the macroeconomic consequences of fiscal deficits, debt sustainability, fiscal targeting and adjustment, countercyclical fiscal policy, approaches to promoting fiscal discipline – it both begins and ends by discussing the important ways in which macrofiscal analysis and PFM interact. This does not mean that PFM practitioners have to master all the issues discussed below, but they need to be aware of these interactions so that PFM can be placed in its proper macroeconomic and fiscal policy context.

Fiscal policy and PFM

The traditional approach to public finance highlights three main fiscal policy functions of government – allocation, distribution and stabilization.¹ Allocation and distribution are primarily microeconomic functions, where the government redirects resources to provide economic, social and administrative infrastructure and services that support growth and economic development, and to transfer income and purchasing power from the advantaged to the disadvantaged to improve social outcomes. The efficiency and equity improvements that result contribute to sustainable growth. Stabilization is a macroeconomic function. While the emphasis used to be primarily on the use of countercyclical fiscal policy to achieve output stability and full employment, attention has over the years shifted more to the harmful macroeconomic consequences of large fiscal deficits and high debt, and the need for macroeconomic stability as a requirement for sustainable growth. The recession and slow recovery that has been a legacy of the global financial crisis has, however, prompted renewed enthusiasm for countercyclical fiscal policy, although it is acknowledged that sizeable fiscal imbalances probably limit its effectiveness.

It is often claimed that PFM is concerned with achieving aggregate fiscal discipline and efficient government spending. Although these objectives overlap with the goals of fiscal policy, which are to achieve macroeconomic stability and sustainable growth, PFM and fiscal policy are ...