Public Finance Analysis and Management: An Overview

Anand Rajaram, PRMPSPFAM Course

PREM Learning Week 2007April 23, 2007

Outline

1. Public Economics and Public Finance Theory

2. Some Empirical Observations

3. 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

4. The Current State of Play

5. Future Directions

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)

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

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)

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)

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

2. Some Empirical Observations

Growth of Government – a relatively recent phenomenon

(In Percent of GDP)

0

10

20

30

40

50

60

70

about 1870 1913 1920 1937 1960 1970 1990 1996

Late 19thCentury

Pre WorldWar I

Post WorldWar I

Pre WorldWar II

Post World War II

Sweden

France

Average

USA

Revenue and Expenditure Vary With Income(% of GDP, 2002)

Total Revenue Total Expenditure

Income Level GG GG CG

Low Income 25.3 30.3 20.5

Lower

Middle-Income30.0 28.9 28.8

Upper

Middle-Income30.4 33.9 28.6

High Income 39.9 39.7 26.6

Note: Cash basis GG=General Government CG=Central Government

Across Countries – Financing Sources also vary

Hi-AAC

UGA

RWA

MDG Low-AAC

CMR

KEN

TJK Hi-MAC

BRA

TUR

UKR Low-MAC

IND

PHL

MOR

Revenue and Expenditure(% GDP)

BRATUR

UKR

MOR

IND

PHL KEN

CMR

TJK

RWA

UGA

MDG

0

5

10

15

20

25

30

35

40

45

50

0 5 10 15 20 25 30 35 40 45 50

Revenue

Exp

end

itu

re

Aid Sustains Spending in some regions

(In Percent of GNI)

0

1

2

3

4

5

6

7

8

EAP

ECA

LAC

MNA

SAR

AFR

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

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

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

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)

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

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

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

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

PER coverage, 1999-2003Select PERs 1999-2003

Reform Strategy

Country Basic

Debt S

usta

in.

Fis

cal R

isk

Revenue

Expenditure

Education

Health

Socia

l

Pro

tection

Rura

l/

Agriculture

Wate

r/

Sanitation

Infa

str

uctu

re

Budget

Form

ula

tion

Budget

Execution

Legis

lative

Accounta

bility

Pro

cure

ment

Civ

il S

erv

ice

Refo

rm

Decentr

aliz

.

National PERsEthiopiaGuinea x x x x x x x x x x xMalawi x x x x x x x xMozambique x x x x x xTanzania x x x x x x x x xUganda x x x x x x x x xZambia - 01 x x x x x x x x x x xZambia - 03 x x x x x x xCambodia x x x x x xIndonesia - 00 x x x x xIndonesia - 98 x x x xMalaysia x x x x x x x x xThailand x x x x x x x x x x x x xVietnam x x x x x x x xAlbania x x xCroatia x x x x x xCzech Rep. x x x x x x x x xCzech Rep. (Intgvnt) x x xKazakhstan x x x x x x x x xKyrgyz Rep. x x x x x x xMacedonia x x x x x x xRussia (PIR) x x xTurkey x x x x x x x x x xBrazil - Northeast x x x x x xNicaragua x x x x x x xPeru x x x x x x x x x xNepal x x x x x x x x x

Provincial PERsEthiopia - Oromiya x x x x x x xEthiopia (Regionaliz) x x x xChina x x x x x x x x x xIndia - Maharashtra x x x x x x x x x xPakistan - Punjab x x x x x x x x x x Total 32 24 8 17 3 20 19 20 9 9 3 12 24 21 7 2 9 10 19

Macro Sector PEM Public SectorBudget

Composition

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

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

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

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?