Budget Institutions in Latin America: What have we learned in the last decade?

1. Budget Institutions in Latin America:What have we learned in the last decade? Ernesto Stein Research Department Inter-American Development Bank

2. Why the interest in BI? • By 1994, when RES was created, fiscal accounts in Latin America had improved substantially: • 1980’s deficits averaged between 5 and 10% of GDP • early 1990’s deficits had declined to 2 % on average, comparable to OECD. • Yet, there were still reasons for concern: • improvement partly due to cycle, privatization receipts. • deficits still higher than OECD when normalized by revenues • striking differences across countries: from 2.5 % surplus in Chile to double digit deficits in Guyana and Suriname.

3. Why the interest in BI? • In Europe, US, similar differences in performance across fairly homogeneous countries (or states) had led scholars to explore role of BI in explaining such differences, with encouraging results. • So in 1994 we invited Alberto Alesina to visit RES, and together with Rudi Hommes and Ricardo, we started a project on BI and fiscal performance.

4. What do we mean by BI? • They are the set of rules, procedures and practices according to which budgets are drafted, approved and implemented (Alesina and Perotti, 1996). • These rules may take various forms: • numerical rules such as limits on debt or deficit • procedural rules, which define the attributes of the different actors that participate in budget process, and rule their interaction. • rules that affect the transparency of the budget.

5. Why would BI matter? • Fiscal decisions not made by social planner. • They are the result of collective process involving a variety of actors, each with its own motivations and incentives. • This generates a number of potential problems, which good BI may help address. • Electoral cycle • Short term horizon of politicians • Principal-agent problems • The common pool problem

6. The common pool problem • Stems from combination of two key features of public budgets: • Government programs generate concentrated benefits, but are financed from common pool of resources. • The budget is the result of a collective decision-making process, involving a variety of agents: • legislators, the finance minister, spending ministers, etc. • Since most of them represent geographical or sectoral interests, under some institutional arrangements this may lead to overutilization of the common pool, thus to excessive spending or deficits. • The tale of the chicken and the lobster.

7. Consumption of chicken and lobster in Latin America

8. How can BI address these problems? • Numerical rules: If enforced, may help deal with many of the problems identified above. But: • generate incentives for creative accounting • unless cyclically adjusted, may reinforce procyclicality of fiscal policy (important feature of fiscal policy in LAC). • Rules affecting transparency may limit agency problems by increasing accountability to voters. • Procedural rules may help by making process more “hierarchical”, concentrating power on those actors that have incentives to deliver fiscal discipline

9. Do BI affect fiscal performance? • International experience suggests that they do • US: States with more stringent balanced budget rules have better fiscal outcomes (lower deficits, lower debt, adjust more quickly to adverse shocks) • EU: J. von Hagen built index of BI based on • relative power of FM in cabinet negotiations • relative power of exec. vis a vis leg. during approval • Degree of expenditure control by executive • Finds that more hierarchical BI reduce deficits and debt, without affecting capacity to stabilize output.

10. Do BI affect fiscal performance? • LAC: AHHS built an index of BI based on a survey responded by budget directors in 20 countries. • We found that more hierarchical BI lead to smaller primary deficits. Similar results for deficits and debt by Stein, Talvi and Grisanti (1998). • Impact of BI robust, and economically important • So BI do matter. • Next question: What to do about it?

11. What to do about BI in LAC? • Numerical rules? • Too inflexible for such a volatile region. • LAC needed solutions that would induce discipline without exacerbating procyclicality. • In this spirit, Eichengreen, Hausmann and von Hagen proposed creation of National Fiscal Councils • autonomous entity that would establish yearly debt ceilings, taking the cycle into consideration • additional role of setting macro assumptions, acting as autonomous scorekeeper between exec and legislature. • NFC proposal generated heated discussions, but no takers.

12. Some recent reforms • Towards the end of 1990s, reform of BI started to resonate in LAC policymaking circles inspired by: • findings of literature • experience of countries such as New Zealand with its Fiscal Responsibility Act of 1994. • crises context that required further fiscal adjustment • In 1998, Venezuela created “Oficina de Asesoría Técnica del Congreso” (CBO style). • In 1999, Argentina and Peru adopted FRLs, combining numerical rules with stabilization funds, changes in procedures and increased transparency.

13. Some recent reforms • In 2000, Brazil adopted very comprehensive FRL, imposing constraints not only at national level, but also at subnational levels of government. • In 2001, Chile adopted a 1% structural surplus rule. • Latecomers to the FRL game: Ecuador (2002) and Colombia (2003)

14. Results have been mixed at best • Venezuela: CBO flourished initially, but has been subject to considerable political interference during current administration. • Argentina and Peru: Numerical rules component of FRL’s never complied with • In Peru, other aspects of the law (e.g. multiannual macro program, increased transparency) changed dynamics of the budget discussions, but overall experience can hardly be considered a success. • Brazil: may be too early for definitive conclusions, but so far results have been encouraging. • Chile: doing quite well under structural surplus rule • (but was doing well before).

15. BI reform: what lessons can we draw? • Lesson 1: The business of reforming BI is is not an easy one. • Lesson 2: When it comes to the design of reforms, the devil is in the details. • In Argentina and Peru, some aspects of the law were very poorly designed. • ordinary law rather than special law (as in Brazil) • no enforcement mechanisms (in Brazil there are severe penalties including jail for non-compliance, and automatic trigger mechanisms to adjust behavior when targets are approached) • conditions for escape clauses in rules not clearly specified.

16. BI reform: what lessons can we draw? • Lesson 3: While it may be tough to get these reforms passed, it is even tougher to make them stick. • Adequate implementation and enforcement requires an external enforcer (such as a capable and independent judiciary) or stakeholders interested in enforcing the rules, and powerful enough to do so. • Lesson 4: The success of reforms depends on the institutional context in which they are embedded. • A good understanding of the policymaking process (i.e., of the key political actors, their incentives and capabilities, the ways they interact, the political transactions they engage in) is a key ingredient for the successful design and implementation of reforms.

17. Budget Institutions in Latin America:What have we learned in the last decade? Ernesto Stein Research Department Inter-American Development Bank