Governance, Corruption and Public Financial Management

CONTENTS Foreword v Yoshihiro Iwasaki Chapter 1 Governance, Corruption, and Public Finance: An Overview 1 Vito Tanzi Part I – PUBLIC FINANCIAL MANAGEMENT Chapter 2 Government Policies and the Budget Process 21 Francesco Forte Chapter 3 Public Financial Management: Getting the Basics Right 47 Arigapudi Premchand Chapter 4 Information and Communication Technology for Public Finance 89 Clay Wescott and Salvatore Schiavo-Campo Chapter 5 Reform Priorities for Public Financial Management in Developing Countries 107 Salvatore Schiavo-Campo and Daniel Tommasi Chapter 6 Beyond the Basics: The Philippine Case 135 Benjamin Diokno IV GOVERNANCE, CORRUPTION, AND PUBLIC FINANCIAL MANAGEMENT Part II – PUBLIC FINANCIAL ACCOUNTABILITY Chapter 7 Public Financial Accountability 145 Arigapudi Premchand Chapter 8 Transparency and Accountability for Public Financial Integrity 193 Nihal Jayawickrama Chapter 9 Some Observations on Public Financial Accountability and Integrity in Pacific Island Countries 207 Savenaca Siwatibau Chapter 10 Public Financial Accountability for Integrity and Results: The Case of the Philippine Bureau of the Treasury 219 Leonor Briones Annexes I An Anti-Corruption Policy for Asia and the Pacific 233 Asian Development Bank II The IMF Code of Fiscal Transparency 243 Note on Contributors 250 FOREWORD eflecting the evolving needs of Asia and the Pacific, the RAsian Development Bank has been transforming itself from primarily a project lender to a broad-based development insti- tution. This transformation is consistent with the international consensus that the development impact of external assistance is crucially linked to the soundness of the recipient country’s economic and social policies. The successful implementation of such policies is in turn linked to the quality of governance and the caliber of a given country’s public sector. It is in recognition of this linkage that the ADB approved in 1995 a policy paper on Governance for Sound Development Management, and in July 1998 an Anti- corruption Policy. These policies on governance and anticor- ruption can only be translated into practice by significant and sustained improvements in the efficiency, integrity, and effec- tiveness of public-sector management, and also in accountability and transparency of corporate and financial governance in the private sector. This is indeed one of the many lessons of the Asian financial crisis. The Bank is determined to heed these lessons and help its member countries turn crisis into oppor- tunity for renewed economic and social progress on a new and stronger basis. Among the many areas of public-sector improvement, strengthening the management of and accountability for public expenditure is central. The challenges faced by developing countries are to strengthen fiscal discipline, bring resource allocation in line with policy priorities, create an enabling environment for public financial managers, and protect due process. The Bank can assist by putting at their disposal the basic conceptual framework, the principles of good budgeting, a synthesis of international consensus on desirable reforms, and the lessons of international experience, both the successes and the failures. This book is one step in this direction. It is our hope that it will prove of VI GOVERNANCE, CORRUPTION, AND PUBLIC FINANCIAL MANAGEMENT practical value and of interest. It is based on a selection of papers presented at two major events organized by the ADB: a Semi- nar on Public Financial Management and Accountability at the 1999 Annual Meeting and the ADB-organized module on the same subject at the World Conference on Governance in Ma- nila in June 1999. Our sincere thanks go to all the eminent contributors, as well as Marilyn Pizarro for research assistance, Me-an Asico for copy-editing, Merly Mallion for organizational assistance, and Ruby de Vera for production assistance. Yoshihiro Iwasaki Chief, Strategy and Policy Office Asian Development Bank Chapter 1 Governance, Corruption, and Public Finance: An Overview Vito Tanzi Introduction Growing attention has been directed in recent years to the role of government. Governance in general and corruption in particular have been much discussed because of the way they affect, and are affected by, the role of government. Dictionaries generally define “governance” as government. Thus, good governance is good government. In recent writing, however, governance has taken on a more substantive, though still not precisely defined, meaning. Good governance is an essential part of a framework for economic and financial management which also includes: macroeconomic stability; commitment to social and economic equity; and the promotion of efficient institutions through structural reforms such as trade liberalization and domestic deregulation. Poor governance may result from factors such as incompetence, ignorance, lack of efficient institutions, the pursuit of economically inefficient ideologies, or misguided economic models. It is often linked to corruption and rent seeking. A good part of this paper will thus deal with corruption. However, it should be understood that corruption is not identical with poor governance, which extends well beyond corruption, although poor governance often leads to corruption and corruption is an important element of poor governance. 2 GOVERNANCE, CORRUPTION, AND PUBLIC FINANCIAL MANAGEMENT Before dealing with governance and corruption issues vis-à-vis public revenue and public expenditure, I would like to note two simple relationships emerging from international experience: (i) corruption is generally less frequent in richer countries; and (ii) there is a negative correlation between the rate of growth and corruption. Thus, more corrupt countries tend to be poorer, and to grow slower (if at all). Corruption Views about corruption have undergone a great change in recent years. Not too many years ago, the economic successes of the countries of South East Asia were attributed by some observers to a presumably positive impact of corruption on facilitating decision making. However, after the crisis of 1997–1998, these views changed and many observers, both inside and outside the crisis countries, blamed corruption for the crisis. For example, it was pointed out that some individual investors had been able to borrow very large sums from banks at low rates, sums which had been invested in highly questionable projects. After the crisis there has been a strong interest in increasing the transparency of institutions and in promoting more arm’s length relationships in economic deals. Whether this interest will generate concrete changes remains to be seen. Corruption has also attracted a lot of attention in Russia, Pakistan, Kenya and many other countries. Many observers have connected the poor functioning of these economies to various governance problems. In fact, there is now a growing awareness among economic observers and economists that these governance problems have a negative impact on economic performance. For this reason, the new architecture for the world financial system is paying a lot of attention to transparency and governance issues. Standard and codes of conduct are being developed and countries are being urged to adhere to them. Governance, Corruption, and Public Finance: An Overview 3 Several international organizations including the Asian Development Bank, the International Monetary Fund, the Inter-American Development Bank, the OECD, and the World Bank have intensified their work in this area and have been promoting a campaign against corruption and for more transparent and well-governed economies. The work of these institutions has been complementary and with a common objective, namely, to promote good governance and by so doing to improve the quality of policy making. It is hoped that this improvement will reduce the frequency and severity of financial crises and will promote economic growth. Until recent years, some economists presented what could be called a romantic view of corruption. Such a view made corruption seem almost a virtuous activity. For example, it was argued that corruption “oiled the economic mechanism” or “greased the economic wheel” and made economies more efficient by removing rigidities which put obstacles to investment and economic activity in general. Some argued that corruption allocated investment to the most efficient uses— because the most efficient investors would be able to pay the highest bribes. Some argued that even the efficiency in the use of time could be improved by corruption because those whose time was most valuable could save on its use by paying the highest bribes to move in front of bureaucratic lines. Finally, it was even argued that corruption made it possible for the government to keep wages low—because the bribes that the public sector employees received made them accept lower wages. Low wages allowed taxes to remain low and low taxes stimulate growth. Various theoretical articles supported these somewhat unorthodox and at times even bizarre conclusions. This romantic view of corruption has been replaced, in more recent years, by a more realistic and much less favorable view. In fact, the more recent view is that, rather than being the oil that lubricates the economic mechanism, corruption is the rust that slows it down. It has been argued that rigidities created 4 GOVERNANCE, CORRUPTION, AND PUBLIC FINANCIAL MANAGEMENT by regulations are not God given but are, rather, man created and thus endogenous to the system. Once bureaucrats

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