35116 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Allen Schick Public ExpenditureManagement A Contemporaryto Approach Governance, Regulation,and FinanceDivision i The findings, interpretations, and conclusions expressed in this document are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organi- zations, or the members of its Board of Executive Directors or the countries they represent. Copyright © 1998 by the International Bank for Reconstruction and Development First Printing May 1998 Second Printing April 1999 The World Bank enjoys copyright protection under protocol 2 of the Universal Copyright Convention. This material may nonetheless be copied for research, educational, or scholarly pur- poses only in the member countries of the World Bank. Material in this series is subject to revision. The views and interpretations in this document are those of the author(s) and should not be attrib- Contents Foreword ....................................................................................................v Chapter 1 An Overview ....................................................................................................1 Chapter 2 Managing Public Expenditure in Developing Countries ................................29 Chapter 3 Aggregate Fiscal Discipline ............................................................................47 Chapter 4 Allocative Efficiency ......................................................................................89 Chapter 5 Operational Efficiency ................................................................................111 Tables Table 1.1: Basic Elements of Public Expenditure Management ........................2 Table 1.2: Institutional Arrangements for Enforcing Aggregate Fiscal Discipline ........................................................................13 Table 1.3: Institutional Arrangements for Improving Allocative Efficiency ..................................................................................16 Table 1.4: Institutional Arrangements for Improving Operational Efficiency ..............................................................................19 Table 2.1: Special Problems of Some Developing Countries ..........................31 Table 2.2: Aggregate Fiscal Discipine Problems of Some Developing Countries................................................................................36 Table 2.3: Allocative Efficiency Problems of Some Developing Countries ......39 iii iv Table 2.4: Operational Efficiency Problems of Some Developing Countries ..41 Table 2.5: Public Expenditure Conditions Associated with Economic Development ....................................................................44 Table 3.1: Controlling the Costs of Entitlements............................................75 Table 3.2: Issues in Managing Financial Risks ................................................77 Table 3.3: Controlling Contingent Liabilities and Other Financial Risks........79 Table 5.1: Types of Expenditure Control ......................................................115 Table 5.2: Instruments for Improving Managerial Accountability ................124 Table 5.3: Types of Output Targets ..............................................................126 Table 5.4: The Definition and Measurement of Cost....................................132 Table 5.5: Using Performance Information to Improve Operations ..............134 Boxes Box 3.1: Australia’s Forward Estimates System ................................................57 Box 3.2: Strengthening Fiscal Discipline in Sweden........................................60 Box 5.1: New Zealand’s Contractual Model..................................................121 Box 5.2: Performance Targets in the United Kingdom..................................129 v Foreword In the last ten to fifteen years, a wave reforms. With their budgets under of change in the management of pub- siege and their economies sagging, lic budgets has swept through devel- many developing countries have began oped countries and has begun to to seek innovative ways of using the engulf many developing countries as national budget more effectively to well. Much of this impetus was promote socio-economic development brought about by dismal macroeco- and to experiment with variants of the nomic performance as reflected in sus- successful reforms in developed coun- tained structural budget deficits and tries. Even the highly successful East balooning national debt. From New Asian economies have began to focus Zealand to the United States, devel- very ardently at reforming their budg- oped countries embarked on a massive etary systems as they now confront the effort of “government reengineering” most serious economic crisis in thirty to restore discipline in the budget years, a shock that has put a serious process and to better target dwindling dent on their public budgets. budgetary resources towards higher In order to encapsulate and dis- priority uses. The resounding success seminate the wealth of knowledge of New Zealand and the more modest embodied in these reforms, the achievements of other developed coun- Economic Development Institute of tries have stimulated a renewed interest the World Bank has developed a course among developing country govern- on Budgeting Processes and the ments in public management reforms Analysis and Management of Public and more specifically on budget Expenditures. Prof. Allen Schick has prepared this manuscript to serve as I have had the great pleasure and the main text for the course. A number privilege of working closely with Prof. of colleagues provided invaluable assis- Schick in molding the substance and tance in shaping the material. Sanjay charting the direction of the course and Pradhan and Malcolm Holmes were the manuscript. It is my hope that both particularly helpful in providing will provide public officials, scholars, (sometimes) stinging but useful com- and practitioners around the world use- ments and suggestions. ful guidance in their efforts to study, develop, and/or implement much needed reforms in the public sector. Jose Edgardo Campos Senior Economist Economic Development Institute The World Bank Chapter 1 An Overview ublic expenditure management PEM covers a broad range of institu- (PEM) is a new approach to an tional and management arrangements, Pold problem. The problem is not just those traditionally associated the allocation of public money with budgeting. PEM recognizes that through collective choice. For more budget outcomes are not likely to be than a century, these allocations have optimal if the public sector is poorly been made through the machinery of structured and managed, or if the budgeting—the routines and proce- incentives and information given poli- dures devised by governments to cy makers and program managers decide the amounts spent, the balance impel them to act in ways that produce between revenue and expenditure, and perverse results. the allocation of funds among public The first critical difference is that activities and entities. PEM operates conventional budgeting operates through budget decisions, but differs through accepted procedural norms, in two important ways from conven- while PEM emphasizes substantive tional budgeting. First, it supplements outcomes. These outcomes pertain to the conventional procedural rules with (a) total revenue and expenditure, (b) substantive policy norms. In PEM, it is the allocation of resources among sec- not enough that governments apply tors and programs, and (c) the efficien- the right procedures; it also is essential cy with which government institutions that they strive to efficiently achieve operate. These elements and their desired policy outcomes. Second, salient characteristics are summarized 1 2 A Contemporary Approach to Public Expenditure Management in Table 1.1. PEM recognizes that even ing and PEM. In the former, what when a government adheres to accept- matters is how the process of budget- ed budget principles, it may fail to ing is organized; PEM by contrast, obtain optimal fiscal outcomes. In fact, casts a broader net that takes into many developing countries have sound account how public institutions are budget and financial management sys- managed. PEM is premised on the tems but still lack fiscal discipline, are notion that budgeting is not a process unable to reallocate resources in accord unto itself but is part of a broader set with strategic priorities, and operate of institutional and governing arrange- inefficiently. ments. To achieve positive public To achieve its preferred outcomes, expenditure outcomes, it is necessary a government must manage public that information, incentives, and other expenditures to implement avowed institutional arrangements be properly policy objectives. It must create an aligned. institutional framework that enhances The reorientation from conven- the probability that actual outcomes tional budgeting to PEM has been will conform to professed targets. This driven by unsatisfactory public expen- consideration leads to the second dif- diture outcomes in many developing ference between conventional budget- and developed countries. Developing Table 1.1: Basic Elements of Public Expenditure Management Aggregate Fiscal Budget totals should be the result of explicit, enforced Discipline decisions; they should not merely accommodate spending demands. These