Managing the People S Money

MANAGING THE PEOPLE’S MONEY: CHALLENGES FOR PUBLIC FINANCE MANAGERS AND INTERNATIONAL ASSISTANCE PROVIDERS

KEYNOTE ADDRESS TO THE INTERNATIONAL CONSORTIUM ON GOVERNMENTAL FINANCIAL MANAGEMENT (ICGFM) MAY 11, 2006 (9:30 – 10:30 a.m.) MIAMI, FLORIDA

William Larry McDonald Deputy Assistant Secretary for Technical Assistance Policy U.S. Treasury Department

Thank you, Jesse, for that kind introduction. I’m very pleased to be here among this distinguished group of government finance managers from around the world, and delighted to have the opportunity to participate in this conference. As you and others in this room know, making our financial systems more effective is a never-ending challenge. I commend ICGFM for taking that challenge head on by organizing peer-led training events that draw upon the experience and professionalism of your membership. As the Deputy Assistant Secretary for Technical Assistance Policy at the U.S. Treasury Department, I’m honored to be part of the three-year training cycle that’s being launched this week.

I also want to recognize the organizations that provide support for ICGFM’s operations, in particular USAID, DFID and CIDA. This event wouldn’t be possible without the support of these institutions and others.

And I’m pleased to be part of this panel of distinguished experts. Gentlemen, I look forward to directing the really tough questions to you.

Today I’d like to share with you some thoughts, and invite your comments, on two themes that strike me as particularly relevant to this conference: First, the importance of sound management of public finance in today’s world; and second, the enduring challenge of providing -- and receiving -- international assistance in a way that best supports the creation of strong public finance systems.

In exploring these themes, I’ll reflect on experience over the past several decades in our joint efforts – as assistance providers and assistance receivers – to build and refine sound public finance systems, and I’ll take a close look at the effort to create integrated financial management information systems. Along the way, I’ll make some observations about approaches that, in my opinion, fall in the category of “good practice,” and some others that fall in the category of “things to be avoided,” to put it politely. During the open discussion part of this session, I hope that members of the audience and the panel 2 will take advantage of the opportunity to comment on anything I say, and to share your own experience. Importance of Sound Public Finance

I suspect that if there’s any setting in the world in which I’m likely to find agreement about the importance of sound public finance, and the key role of public finance managers, it’s right here in this room. And yet, I also suspect that, in the press of our day-to-day responsibilities, we may occasionally lose sight of just how important it is to be managers of the people’s money.

Putting it that way – managing the people’s money – suggests the central importance of public finance: as stewards of public financial resources, we – you – play a fundamental role in the effectiveness and credibility of the institutions of state. Those institutions can do nothing without finance -- or at least can’t do it very well or for very long. As professionals in the various disciplines that constitute public finance management, your success or failure goes a long way to determining whether government works, and whether it’s credible in the eyes of the people.

The Treasury Department is so convinced of the importance of fostering sound public finance that it has created an assistance program that offers comprehensive technical assistance and policy advice to developing and transition economies in the areas of budget policy and management; tax policy and administration; government debt issuance and management; financial enforcement; and banking and financial institutions. If you’re interested in knowing more about the Treasury’s assistance program, my colleague Mr. Bartholomew will tell you a little later about how to access information about what we do.

Within the area of public finance, we’re focusing in this morning’s session on budgeting and accounting. At first glance that may seem like a rather technical and narrow subject. I don’t think so. In my view, this subject is central to some of the most important issues in international development and international relations. Over the past several years, I’ve been a member of a number of senior-level U.S. delegations that participated in international donors’ conferences or in bilateral meetings with individual donors in which the goal was to urge those donors to increase their economic support for countries in need. In many cases, donors cite the absence of a sound budget and accounting system as one of the main reasons why they don’t provide greater assistance. Are they being sincere or are they making excuses? Perhaps some of both. Donors do have a legitimate interest in knowing whether there’s a credible system in place that will help ensure that assistance is accounted for and used for the purposes for which it was provided. At the same time, the absence, or rarity, of strong accounting and budget systems in the developing world is a convenient excuse for not giving more. In any event, it is a significant limiting factor in the amount of assistance that’s provided.

In addition, it’s a very important factor affecting the way in which assistance is provided. Weak budget and accounting systems in developing and transition economies encourage donors to go around national authorities and institutions. Large donors set up 3 their own aid delivery systems. Smaller donors make use of special donor trust funds that are managed by multilateral institutions or by groups of donors. How many times I have heard Finance Ministers or Ministers of Planning express their frustration that development assistance takes place in a kind of parallel universe rather than being an integral part of the national development strategy, national budget, and national institutions. Moreover, when assistance is not integrated into national budget systems, it may increase pressure on the government’s operating budget. As you well know, development projects generate operating and maintenance costs. Sometimes, and with the best of intentions, donors build things that the recipient country simply can’t afford to maintain. That’s a real problem in some countries.

In short, I strongly believe that the focus of this session is one of the most important issues facing developing countries and international assistance providers.

The Challenge of Strengthening Public Finance: Early Days

It is one thing to recognize the importance of sound budget, accounting, and public finance systems. It’s another thing to build them. In the post-colonial era, and in particular since the fall of communism, assistance providers have tried to strengthen public finance systems as part of the broader effort to support economic development and transition. Experience has been mixed and we’re still learning.

In the early days of the post-colonial world, the colonial systems served as the foundation upon which changes were designed and implemented. Often, reforms were incrementally improved procedural upgrades, rather than wholly new approaches. Foreign advisors tended to arrive with a view that they knew what was needed. And it’s probably the case that many of their counterparts shared that view, at least for a time.

In the post-communist transition countries, that dynamic was repeated and in some ways accentuated. Local officials found themselves in the midst of many technical assistance providers, primarily from the International Financial Institutions and OECD countries. The assistance providers tended to recommend public finance models and offer advice based on their understanding of what constituted “best practice.”

The IMF and World Bank were usually the first multilateral institutions to engage. The Fund focused on helping transition countries develop consolidated budgets that classified spending in transparent, internationally accepted economic and functional classifications: the so called GFS classification model. Using these classifications makes national finances more transparent and comparable. That’s a good thing. These technical improvements were often a prerequisite for IMF financing.

The World Bank provided access to project and policy-based financing as well as technical assistance. In return, the Bank sought commitments from the recipient country to increase transparency, develop “Medium Term Frameworks,” and undertake structural reforms intended to refit old socialist systems to new economic circumstances. 4

Other public sector and private sector assistance providers joined in, including the Treasury Department. Treasury’s technical assistance program was created specifically to support transition in Eastern Europe and the Former Soviet Union. In later years, the program expanded into other regions. Our advisors helped organize single account treasuries, wrote new budget and tax laws, and generally worked closely with reform- minded finance ministers who asked us to build up their organizational capacity to implement the reforms that the IMF, World Bank and others were recommending. There was some good team-work that took place during that period, and that continues.

At the same time, assistance providers occasionally bumped into each other a bit, either donating or selling advice and systems that reflected practices in their individual countries of origin. “International best practice” was sometimes difficult to distinguish from “country of origin practice.” And sometimes countries were urged to adopt far- reaching reforms that were still a work in progress in the donor’s home country.

Focus on IFMIS

To illustrate more concretely the challenges and difficulties of building sound public finance systems, let me focus for a moment on the experience of efforts to build integrated financial management information systems.

IFMIS, as you well know, is a system that’s intended to help public finance managers know how much money they have, where it is, and how it’s being used. Sounds simple. And yet, to a significant degree, it’s often represented as the Holy Grail of public finance management. Many aspire to possess it. Fewer achieve the mastery of it. As a consequence, public finance management in many countries is more of an art than a science, since the information technology in use is not properly fit to public finance requirements. Sometimes, let us admit, we engage in guesswork, because we don’t have the data in a timely and useful format. And this despite many years of effort, much money spent, and much technical assistance provided with the goal of giving public finance managers the proper IT tools they need to do their job well. Why is that the case? Why is this so hard to do well? There are a number of factors at play, affecting both donors and recipient countries.

Donors, for their part, tend to want the best for their counterparts. It’s understandable. The donors are accustomed to having sophisticated systems that handle data in multiple classifications and in real time. So it seems logical to them that beneficiary countries would be much better off with a fast, modern system to manage the budget and inform financial policy decisions.

In addition, donors are motivated by a desire to see their counter-parts progress as quickly as possible. We’re interested in seeing progress for its own sake, for the good of the recipient country, and, if it reflects well upon us too, that’s fine.

It should also be acknowledged that sometimes donors are motivated by national and/or corporate commercial interests. Corporations have many products and services to 5 offer – the latest in hardware, software and training. Donors see “win-win” scenarios in which their national corporate partners can profit at the same time that the recipient country upgrades its public finance capacity.

The dynamics in recipient countries are no less powerful. Economic leaders may envision themselves taking their organizations and governments into a new era by obtaining advanced IFMIS systems. They may have participated in study tours and observed other countries benefiting from real time financial data on the state of budget execution. Who can blame them for wanting the same thing for their own institutions?

Mid-level managers and line workers, for their part, are also eager to have the technical advantages and status that they see coming to them when a sophisticated system is installed on their desks. It’s perfectly natural for them to see this as a big step forward in professional capacity and prestige.

I mentioned a moment ago that donors are motivated by a desire to see rapid progress. It stands to reason that recipients are doubly interested. For countries suffering from poverty, there’s a compelling and understandable attraction to systems that seem to offer the possibility of moving faster and farther.

Alas, experience shows that efforts to install advanced systems quickly can lead to disappointment, for both donors and their partners. Ministry and treasury staff find themselves unable to use the new systems effectively, and sometimes discover that the new IFMIS does many things but not necessarily all of the things they want. Too often, staff end up keeping a separate set of data on old fashioned (but familiar) spreadsheets so they can answer the questions they’re asked and meet their deadlines. Observing this, donors feel frustrated that their support is not being used to its greatest effect, or in some cases not at all.

This unhappy state of affairs arises for many reasons. Let me mention a few.

First, design features sometimes get locked in before the users know enough to engage knowledgably with the donor about design options.

Second, funding for training tends to take a lower priority to hardware and software expenses.

Third, some corporate off-the-shelf systems simply don’t lend themselves to public sector finance needs. In most countries, budgeting is not about balance sheets; and accountability needs can be dramatically different between the public and private sectors.

In short, everybody is subject to one kind of pressure or another, which leads to mistakes. And the mistakes can be costly. 6

Lessons Learned

Looking back on my own organization’s experience, I can say that we, too, have made our share of mistakes and sometimes had to learn the hard way. If I may, let me share some of the lessons that we’ve learned. These are the outgrowth of our experience working on budget and financial management information systems in particular, but apply equally well, I believe, to assistance more broadly.

 First, ALWAYS start with the counterpart’s expressed needs. Take the time to understand the counterpart’s real needs and design jointly a solution that’s realistic for the counterpart’s circumstances. In this connection, both parties should be ready to reject popular approaches. Just because a particular system worked in one country doesn’t mean it will work in another.

 Second, have realistic expectations and be willing to adjust along the way, even if that entails delay. Doing the job effectively is more important than doing it as originally planned. Getting it right is more important than getting it fast. I want to emphasize here that I’m not advocating that advanced IFMIS or any proven public finance practice should be withheld from developing economies, or that one should go slow for the sake of going slow. My point is that we all need to do better in planning for and phasing in systems at a pace that’s commensurate with the recipient country’s capacity to absorb.

 Third, be ready to stop truly ineffective projects. This is a very tough decision to make, especially when both the donor and the counterparts have invested a great deal in a project.

In a more general way, I want to stress the need to give special attention to increasing transparency, identifying and addressing risks, and focusing on real outcomes. Specifically, this entails guarding against five practices that undermine sound finance: i. First, hidden, contingent liabilities, such as government guarantees for economic development projects; ii. Second, intentionally underestimated budget allocations and higher-than-realistic revenue targets; at the very least, these can force big budget amendments and, if repeated often enough, will undermine the credibility of the budget process; iii. Third, badly supervised banking systems, loaded with unknown moral hazard risk to the budget; iv. Fourth, inadequate internal and external audit resources that cannot uncover problems; v. And fifth, budget execution manipulations that substantially rewrite the published budget approved by parliament.

In public finance, we need to concentrate on building processes that focus on results, not hopes and promises. What is the real budget in your country? The one that 7

Parliament enacts, or the one that’s eventually executed? How big a difference is there between the two versions? In his presentation, Rich Bartholomew will go more deeply into the importance of budget execution and the internal controls and processes that are essential for sound budget execution.

Latest and Future Trends

I would like to touch on a few of the latest trends among assistance providers to support sound management of public finance generally, and budget technical assistance more specifically. Overall, I find myself encouraged by these developments, with some exceptions.

The current trend in donor technical assistance, broadly speaking, is to emphasize in-country leadership and accountability, localized project definition, and gradual change. This trend has grown out of a series of conferences and Joint Venture activities that I understand have been discussed earlier this week. Some refer to this concept as the “Strengthened Approach.” The strengthening refers primarily to the role of host country officials.

One specific manifestation of this general trend is an initiative on which the British have taken the lead. Gradual, sequenced reform is at the heart of what they call the “Platform Approach.” I have a slide here which depicts this approach as applied in the case of Cambodia. As you can see, one step builds upon another, with systems and procedures built up in layers, and complemented by broader activities and reforms in related areas. 8

The target date for completion of these activities is 2014. That is a notional target. The actual timeline will be determined by Cambodia’s actions.

The Platform Approach is not a wholly new paradigm. The notion of sequencing has been around for a good while. The value of this approach, in my view, is that it clearly breaks down the various steps involved in strengthening the budget, and shows how those steps relate to other related reforms, referred to as “broad activities.” And in this approach, there is no rush to design and install an FMIS. Note that the full design of the FMIS does not occur until step 4.

What are the future trends in public finance and the budget sector? I think we can discern several.

One is the growing importance of indicators that allow one to measure progress. The major donors recently endorsed a set of public finance (PEFA) indicators, which have already been mentioned frequently this week. Richard will describe them in more detail. The PEFA indicators represent an honest attempt to identify meaningful and transparent standards that will be useful to all parties involved in strengthening public finance systems. 9

A second emerging trend – one which causes OTA some concern, to tell you the truth -- is the turn to Accrual Accounting, which is advocated by the IMF, the EU and some people in this room. OTA’s concern is that this method will cause confusion in public budgeting systems that do not yet have the capacity to embrace it. Accrual accounting has undeniable benefits, once it is successfully implemented and well understood, but my earlier comments about the importance of pacing the introduction of IFMIS applies here as well.

Another future and enduring issue is that of long range, sustainable budgeting. The sustainability of budgetary benefits that countries provide to their citizens will continue to be a central public finance issue for most countries.

Finally, and in closing, I want to recognize and applaud the growing importance of practitioner groups, such as this one. The Senior Budget Officers groups, your organization, the International Organization of Supreme Audit Institutions (INTOSAI), and burgeoning organizations of treasurers and other public finance disciplines can, I believe, become ever more important and valuable in setting the agenda for international technical assistance. They can be extremely valuable in serving as a mechanism for capacity building, and in fostering leadership among peers. This conference is a fine example of that trend, and OTA supports it.

I thank you for the opportunity to speak with you today, and I look forward to hearing your views and the thoughts of the other members of the panel.