Public Finance Analysis and Management: An Overview

1. Public Finance Analysis and Management: An Overview Anand Rajaram, PRMPS PFAM Course PREM Learning Week 2007 April 23, 2007

2. Outline • Public Economics and Public Finance Theory • Some Empirical Observations • The Evolution of Bank work on Public Finance • the link to lending and CAS • From policy to management • Response to fiduciary concerns • Measuring PFM performance • The Current State of Play • Future Directions

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

4. 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 force • protecting 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

5. 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 growth • To use public policy instruments to improve equity and protect the vulnerable • Need to take into account the scope for government failure • Political and economic ideology determines size and scope for government (ISI, welfare state, urbanization, health pandemics, regional conflicts, ODA)

6. 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 collection • Efficiency requires taxing goods that are inelastic, tax consumption rather than labor or capital, use broad based taxes • Debt is a form of deferred revenue raising (Ricardian equivalence)

7. Public spending • Theory offers some general principles for expenditure policy • Public expenditure is inefficient if it crowds out private expenditure • Some 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

8. 2. Some Empirical Observations

9. Growth of Government – a relatively recent phenomenon

10. Revenue and Expenditure Vary With Income(% of GDP, 2002) Note: Cash basis GG=General Government CG=Central Government

11. Across Countries – Financing Sources also vary

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

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

14. Missing variables • Intuitively, differences in policies and institutions could explain the weak expenditure-outcome link across countries • WDR 2004 identified some core elements: • Budget policy and management • Organization of tiers of government • Quality of public administration • Other factors – role of private sector

15. Typical budget pathologies in LICs • Overambitious development plans, unclear policies • Unrealistic budgets • No disciplined link between policy, plan and budget • Incremental budgeting, no forward perspective • Non-transparency - extra-budgetary funds, lack of comprehensive budget framework • Budget execution marred by unpredictable allocations, including interruptions in flow of funds • Symptoms of problems: arrears in payments to suppliers, unpaid bills to utilities, incomplete projects, lack of maintenance of assets, poor services • Tax evasion

16. 3. Evolution of Bank PER work • In the 1980s, focus limited to investment budget – identifying “white elephants” • With SAL and budget support, broader concern for overall budget in the 1990s • By late-90s, growing focus on PEM and reduced focus on policy • Early 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)

17. Role of the PER • The PER provides Bank management and Board with a view on the quality of budget policy and management in a country • Used to determine if “budget support” is appropriate • Whether policies are sustainable or efficient • Whether the budget is aligned with policy objectives • Whether budgetary processes support effective implementation and policy outcomes • To advise the government on options for reform of policy and/or management • To support government in designing and implementing reform and building capacity

18. 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 targets • So, fiscal (deficit) policy is given by IMF program • PER 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 objectives • No true long term perspective to guide fiscal policy

19. PERs Differ in Coverage and Approach • In general, recent PERs expected to cover more issues • Relative emphasis on policy or management or special topics may differ across PERs • Differences also in degree of “participation” by government counterparts • Different approaches to integrating with related products – CFAA and CPAR • PERs beginning to take the form, not of a single report, but a sequence of complementary analytical modules to support government reforms

20. Examples of PERs – varied formats • PIR as a supplement to Customized BM report: Russia • The PEM and the PEP: Mozambique (2001), (2003) • PE Reform support to MTEF: Albania (2001) • Bank supplement to Govt PER: Malawi, Tanzania, Zambia • PEIRs: Turkey, Macedonia, Croatia, Bosnia • Annual PERs with regional supplement – Ethiopia (2001) • Annual PE process report: Uganda • PERs w/Intergovt.Fiscal – Czech,Thailand, Kazakh,Bosnia • Provincial PERs – Punjab (Pakistan), Maharashtra (India) Indonesia, China • Integrated PEM reports: Philippines, Iran, Zambia

21. PER coverage, 1999-2003

22. Have Bank-Fund roles been effective? • Fund leads on “stabilization” issues and forms view on aggregate fiscal stance • Fund has greater capacity on revenue policy and administration while Bank does finance tax admin. projects • Bank leads on “allocative” and “distributive” issues w.r.t. budgets • Both IFIs provide advice on PEM • But this form of collaboration has its limitations and does not serve clients well

23. 4. Current State of Play • In recent years, governments have complained about fiscal policy – demand for fiscal space for growth • IMF papers on public investment and fiscal policy concluded that changes in fiscal rules would be risky and unwarranted • Bank asked to provide a developmental perspective on fiscal policy and scope to better support growth • Two papers to Dev. Committee lays out our view

24. 5. Future Directions • PRMVP speech underlined importance of fiscal work • Bank will adopt a “public finance” perspective, encompassing revenue, aid, debt and expenditure • New growth diagnostics approach (Rodrik, Hausmann) provides basis to link public expenditure and fiscal policy to growth • Efficiency analysis and incidence work at the sector level will be key to improving advice to governments – including exciting new experimental approaches at MIT poverty lab

25. Annex • Join the Public Finance thematic group to hear about BBLs and to have access to a community of practitioners • Visit Public Finance website at: • http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPUBLICSECTORANDGOVERNANCE/EXTPUBLICFINANCE/0,,menuPK:1339576~pagePK:149018~piPK:149093~theSitePK:1339564,00.html?