Public Finance Analysis and Management: An Overview

Anand Rajaram, PRMPS

PFAM Course

PREM Learning Week 2007

April 23, 2007

Outline

Public Economics and Public Finance Theory

Some Empirical Observations

The Evolution of Bank work on Public Finance

the link to lending and CASFrom policy to managementResponse to fiduciary concernsMeasuring PFM performance

The Current State of Play

Future Directions

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 inefficiencySubsequent recognition of market failures- barriers to entry/exit, public goods, externalities, incomplete markets, information and coordination problems, macro-disequilibrium (Stiglitz)

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 forceprotecting 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

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 growthTo use public policy instruments to improve equity and protect the vulnerableNeed to take into account the scope for government failurePolitical and economic ideology determines size and scope for government (ISI, welfare state, urbanization, health pandemics, regional conflicts, ODA)

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 collectionEfficiency requires taxing goods that are inelastic, tax consumption rather than labor or capital, use broad based taxesDebt is a form of deferred revenue raising (Ricardian equivalence)

Public spending

Theory offers some general principles for expenditure policyPublic expenditure is inefficient if it crowds out private expenditureSome 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 g&s to the poor or other target groups

2. Some Empirical Observations

Growth of Government a relatively recent phenomenon

Revenue and Expenditure Vary With Income(% of GDP, 2002)

Note: Cash basisGG=General GovernmentCG=Central Government

Total RevenueTotal ExpenditureIncome LevelGGGGCGLow Income25.330.320.5Lower Middle-Income30.028.928.8Upper Middle-Income30.433.928.6High Income39.939.726.6

Across Countries Financing Sources also vary

Aid Sustains Spending in some regions (In Percent of GNI)

Public spending and sector outcomes are often weakly related (WDR 2004)

Missing variables

Intuitively, differences in policies and institutions could explain the weak expenditure-outcome link across countriesWDR 2004 identified some core elements:Budget policy and managementOrganization of tiers of governmentQuality of public administrationOther factors role of private sector

Typical budget pathologies in LICs

Overambitious development plans, unclear policiesUnrealistic budgets No disciplined link between policy, plan and budgetIncremental budgeting, no forward perspectiveNon-transparency - extra-budgetary funds, lack of comprehensive budget frameworkBudget execution marred by unpredictable allocations, including interruptions in flow of fundsSymptoms of problems: arrears in payments to suppliers, unpaid bills to utilities, incomplete projects, lack of maintenance of assets, poor servicesTax evasion

3.Evolution of Bank PER work

In the 1980s, focus limited to investment budget identifying white elephantsWith SAL and budget support, broader concern for overall budget in the 1990sBy late-90s, growing focus on PEM and reduced focus on policyEarly 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)

Role of the PER

The PER provides Bank management and Board with a view on the quality of budget policy and management in a countryUsed to determine if budget support is appropriateWhether policies are sustainable or efficientWhether the budget is aligned with policy objectivesWhether budgetary processes support effective implementation and policy outcomesTo advise the government on options for reform of policy and/or managementTo support government in designing and implementing reform and building capacity

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 targetsSo, fiscal (deficit) policy is given by IMF programPER 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 objectivesNo true long term perspective to guide fiscal policy

PERs Differ in Coverage and Approach

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

Examples of PERs varied formats

PIR as a supplement to Customized BM report: RussiaThe PEM and the PEP: Mozambique (2001), (2003)PE Reform support to MTEF: Albania (2001)Bank supplement to Govt PER: Malawi, Tanzania, ZambiaPEIRs: Turkey, Macedonia, Croatia, BosniaAnnual PERs with regional supplement Ethiopia (2001) Annual PE process report: UgandaPERs w/Intergovt.Fiscal Czech,Thailand, Kazakh,BosniaProvincial PERs Punjab (Pakistan), Maharashtra (India)

Indonesia, China

Integrated PEM reports: Philippines, Iran, Zambia

PER coverage, 1999-2003

Data

Reform

RegionCountryTitleYearMacro IssuesPEM issuesSector IssuesOther pub sectorReform StrategyOperationalTMProcess

National PERs

AFREthiopiaFocusing PE onDec-01fiscal trendstracking PEsector expenditures

Poverty Reduction, 3 vol.sustainabilityincreasing& poverty

MTFFpoverty focusshift to sector &

budget support

GuineaPERNov-03fiscal risksbudget preparationeducationpublic enterprisesaction planE. Larbi

Strengthening PEM forfiscal sustainabilityMTEFhealthcivil service reformpolicy matrix

Poverty Reduction &revenue mobilizationPIPrural developmenttax regime

Growthpoverty & growthbudget execution

decentralization of PE

composition of PE

MalawiPE:IssuesSep-01basicexec & monitoringeducation - incidencepensionsYesH. Zaman

& OptionssequencinghealthparastatalsSR-

(supplement to GOMincentivesagricultureexec

PER)roadsLR-pay

reform

MozambiquePEM ReviewDec-01macro fiscalformulationintergovt fiscalJ. Leandro

(joint donor review)contingent liabilitiescov & transp

execution

acct & cash mgt

evaluation & audit

new PFM law

TanzaniaPER Managing PE forJun-03basicstrategic resourcesectoral PERs:revenuepolicy matrixR. Utz

Poverty Reduction Reportfiscal performanceallocationeducation

on Fiscal Developments &budget executionhealth

PE Management Issuesbudget & PRSP principleswater

pro-poor expendituresroads

local government budgetagriculture

budget mgtMTEF & sec. PERs

UgandaPERSep-03growth performanceMTEFwater & sanitationdecentralizationPEAPS. Canagarajah

fiscal sustainabilitybudget executionhealthLTEF

PE efficiency

LG budget & fin management

ZambiaPERSep-01macro constrmgmt constreducationHR managementD. Go

Public Expenditurepoverty, inequalityfiscal riskshealthrole of parliament in

Growth & Poverty -composition of PEbudget preparationwaterbudget formulation

A Synthesisbudget executionagriculture

(supplement to govtinfrastructure

PER 1995-2000)

ZambiaPEM & Fin Account ReviewNov-03poverty & social outcomesbudget preparationeducationparliamentary oversightpolicy matrixA. Adugna

Integrated Assessment,equitable & transparentMTEFpublic access to info

3 Vol.resource managementbudget comprehensivenessHR & pay reform

budget execution

& control

legal framew. for PFM

EAPCambodiaPERJan-99povertycomposition of pub spendinghealthrole of governmentreformS. Song

Enhancing Effectivenessfiscal performanceplanning, policy & budg