Public Financial Public Financial Management: “New Management: “New

Institutional Economics Institutional Economics Approach”Approach”

Wihana Kirana Jaya, Wihana Kirana Jaya,

wihanajaya@feb.ugm.ac.idwihanajaya@feb.ugm.ac.id

IntroductionIntroduction

Dysfunctional PFM (predatory or Dysfunctional PFM (predatory or contract regime?)contract regime?)

Lack of research on NIE?Lack of research on NIE? Lack of good policy ?Lack of good policy ? Need a new paradigm?Need a new paradigm?

The NIE is “New”The NIE is “New” To distinguish it from the ‘old” To distinguish it from the ‘old”

institutional economists such as institutional economists such as Thorsten Veblen, John R. Commons, Thorsten Veblen, John R. Commons, Wesley Mitchell and Clarence AyresWesley Mitchell and Clarence Ayres

The old institutional economics was The old institutional economics was economics with institutions but economics with institutions but without theory; standard neoclassical without theory; standard neoclassical economics; and the NIE is attempting economics; and the NIE is attempting to provide economics with both to provide economics with both theory and institutionstheory and institutions

NIENIE The new institutional economics, or The new institutional economics, or

NIE, is a branch of economics that NIE, is a branch of economics that especially incorporates various especially incorporates various institutional constraints into formal institutional constraints into formal economic analysis in order to explain, economic analysis in order to explain, on the basis of rational choice, on the basis of rational choice, observable real-world phenomena that observable real-world phenomena that standard neoclassical economicsstandard neoclassical economics (absent institutional constraints) is (absent institutional constraints) is unable to explain, except by assuming unable to explain, except by assuming irrational behavior on the part of irrational behavior on the part of individual economic agentsindividual economic agents

Institutions of PFMInstitutions of PFM

Laws and regulationsLaws and regulations ContractsContracts Constitutional lawsConstitutional laws

InformalInformal::

TrustTrust Ethics or valuesEthics or values Political normsPolitical norms

Formal:Formal:

Organization of PFMOrganization of PFM

Organizations are sets of actors Organizations are sets of actors who collectively pursue common who collectively pursue common objectivesobjectives

Political organizationPolitical organization Economic organizationEconomic organization Social organizationSocial organization Educational organizationEducational organization PFM OrganizationPFM Organization

Institutions are the rules in PFM that Institutions are the rules in PFM that shape the behavior of organizations shape the behavior of organizations and individuals in a societyand individuals in a society

Reforming PFM institutions are rules Reforming PFM institutions are rules that determine the non price that determine the non price intensives for the behavior of intensives for the behavior of individual and organizationsindividual and organizations

Rules may solve information and Rules may solve information and enforcement PFM problemsenforcement PFM problems

PFM InstitutionsPFM Institutions

Embedded ness:informal institutions, customs,

Tradition, norms religion

Embedded ness:informal institutions, customs,

Tradition, norms religion

Institutional environment:Formal rules of the game-esp. property

(polity, judiciary, bureaucracy)

Institutional environment:Formal rules of the game-esp. property

(polity, judiciary, bureaucracy)

Governance:Play of the game-esp.

contract (aligning governance Structures with transactions)

Governance:Play of the game-esp.

contract (aligning governance Structures with transactions)

Resource allocation and employment(prices and quantities; incentive alignment)

Resource allocation and employment(prices and quantities; incentive alignment)

Social theory (L1)

Economics ofProperty rights/Positive politicalTheory (L2)

Transaction costEconomics (L3)

NeoclassicalEconomics/Agency theory (L4)

LEVEL

The Concept of Property The Concept of Property Right of PFMRight of PFM

There are the rights to use an There are the rights to use an assetasset

The right to earn income from an The right to earn income from an asset and contractasset and contract

The right to transfer The right to transfer permanently to another party permanently to another party ownership right over an asset ownership right over an asset (sell an asset)(sell an asset)

The Concept of Transaction The Concept of Transaction Cost of PFMCost of PFM

Consist of the cost of measuring Consist of the cost of measuring the attribute of what is being the attribute of what is being exchange and the cost of exchange and the cost of protecting right, policing and protecting right, policing and enforcing agreementenforcing agreement

Depend on human behavior Depend on human behavior assumptions i.e. assumptions i.e. bounded bounded rationalityrationality and and opportunismopportunism

The Concept of Contract The Concept of Contract of PFMof PFM

Manifestations of intention to act Manifestations of intention to act or refrain from acting in a or refrain from acting in a specified wayspecified way

The choice of contracts is The choice of contracts is determine by transaction cost, determine by transaction cost, economic risk and legal economic risk and legal arrangementarrangement

The Concept of Agency The Concept of Agency theory of PFMtheory of PFM

The relationship between two The relationship between two parties, a principal and an agent parties, a principal and an agent who makes decisions on the who makes decisions on the behalf of the principal (market behalf of the principal (market and hierarchies)and hierarchies)

Information and enforcement Information and enforcement problems trigger adverse problems trigger adverse selection and moral hazardselection and moral hazard

13

INSTITUTION of PFM

Rule of the Games of

PFM

Organization of PFM

(Players)

Level 1:Embeddedness

Level 2:InstitutionalEnvironment

Level 3:Governance structures

Level 4:Resource Allocations & Employment

Informal institutions: customs, traditions, norms & religion

Formal rules: esp. property rights

Business firms, contract system, public bureaucracies, nonprofit organization

P & Q; incentive alignment (agency theory)

Reduce uncertainty

Reduce Transaction

Cost

Enhance:1. Macro level:Efficiency, productivity, investment, and economic growth2. Micro level:Efficiency, productivity, profitability, and sustainability

PFM OUTCOMES

THE ROLE OF INSTITUTION INTHE ROLE OF INSTITUTION IN PFM PFM

PEMDA

PEMPUS

TOTAL PENERIMAAN DAERAH

-Asimetry information-Bargaining cost-Principal agent relationship-Law enforcement-Hidden Action-Lobbying Modus

Application of the NIE Application of the NIE

States: as a network of relational States: as a network of relational principal-agent contracts between principal-agent contracts between the constituents and their the constituents and their representatives (agents)representatives (agents)

Theory of the StateTheory of the State

Contracts theory: the role of the Contracts theory: the role of the state is to ensure wealth state is to ensure wealth maximization, efficient regime of maximization, efficient regime of growth, promoting property rightsgrowth, promoting property rights

Predatory or exploitations theory: Predatory or exploitations theory: state is controlled by ruling cliques or state is controlled by ruling cliques or classes, and they maximize their classes, and they maximize their incomesincomes

MethodologyMethodology

Triangulate Data CollectionTriangulate Data Collection Sampling methodSampling method Non Parametric Data and AnalysisNon Parametric Data and Analysis PerceptionsPerceptions

Empirical Discussion: Empirical Discussion: 1. Fiscal Power1. Fiscal Power

Own Own RevenueRevenue

Bengkalis Bengkalis ScoreScore

Sleman Sleman ScoreScore

Badung Badung ScoreScore

Kupang Kupang ScoreScore

Own Tax Own Tax ReceiptReceipt

3.4(0.9)3.4(0.9) 3.2(1.2)3.2(1.2) 3.6(0.8)3.6(0.8) 4.1(0.9)4.1(0.9)

Charge or Charge or levieslevies

3.2(0.9)3.2(0.9) 3.4(0.8)3.4(0.8) 3.5(0.9)3.5(0.9) 3.8(0.6)3.8(0.6)

Local Local EnterpriseEnterprise

3.2(0.9)3.2(0.9) 2.8(1.0)2.8(1.0) 3.2(0.9)3.2(0.9) 3.1(0.8)3.1(0.8)

OthersOthers 3.2(1.2)3.2(1.2) 3.1(0.8)3.1(0.8) 3.4(0.9)3.4(0.9) 3.6(1.0)3.6(1.0)

Note : Value and score are mean and standard deviation

Bengkalis Sleman Badung KupangIncentive for local Government 3.8 (1.0) 3.1 (1.0) 3.3 (1.2) 3.3 (1.3)Incentive for Local Council 3.9 (1.1) 3.1 (1.2) 3.0 (1.2) 3.0 (1.3)Incentive for Community 4.1 (0.7) 3.4 (1.0) 3.0 (1.2) 3.4 (1.0)Incentive for Local Private 3.7 (1.3) 3.2 (0.9) 2.9 (1.1) 3.5 (0.7)Transparent Voter-Local Council 3.2 (1.2) 2.7 (1.1) 3.0 (1.2) 2.7 (1.0)Transparent Local Council-Local Government 3.8 (0.9) 3.2 (1.3) 2.8 (0.9) 3.5 (1.0)Transparent Local Government-Community 3.9 (1.0) 3.1 (1.2) 3.2 (1.0) 3.3 (1.2)Transparent Local Government-Private Party 3.6 (0.8) 3.0 (0.9) 2.8 (1.0 3.3 (1.2)Transparent Local Council-Private Party 3.5 (0.7) 2.8 (1.0) 2.6 (0.9) 3.0 (1.1)Monitoring to Local Government 3.8 ((1.0) 3.2 (1.1) 2.9 (1.0) 3.6 (0.8)Monitoring to Local Council 3.9 (1.0) 2.9 (1.2) 2.8 (0.9) 3.7 (0.9)

Institutions VariablesScore

Value in scores are mean and standard deviation

2. Local Elite behaviour

Sleman Badung KupangIncentive positve 2.7 (0.9) 2.7 (0.6) 3.4 (1.1)Predictability of Law 2.7 (0.8) 2.7 (0.6) 3.4 ((1.0)Security of Property 2.5 (0.8) 2.5 (0.7) 3.2 (1.0)Political Conflicts 3.3 (1.1) 3.4 (1.2) 3.2 (1,4)Transaction Cost 3.5 (1.0) 3.8 (1.1) 3.2 (1.3)Regulation on labour 2.6 (1.1) 2.6 (0.7) 3.0 (1.1)Lobbying 3.4 (1.0) 3.3 (0.8) 3.7 (1.3)Informal Charge 2.6 (1.1) 2.5 (1.4) 2.4 (1.1)Competitiveness 3.4 (0.7) 3.3 (0.8) 3.7 (1.0)

ScoreInsitutional Variables

3. Local Businessmen Perceptions

Note : Value and score are mean and standard deviation

Matrix of Correlation Coefficient,institutional assessment Matrix of Correlation Coefficient,institutional assessment

( results of Spearman’s rho )( results of Spearman’s rho )

BusinessBusiness

PerformancePerformance

LobbyingLobbying

costcost

TransactioTransactionn

costcost

PoliticalPolitical

conflictsconflicts

UncertaintyUncertainty

regulationregulation

SecuritySecurity

Property rightsProperty rights

PredictabiliyPredictabiliy

Of lawOf law

IncentiveIncentive

BusinessBusiness

PerformancePerformance

1.001.00

LobbyingLobbying

costcost

-.08-.08

(.47)(.47)

1.001.00

TransactionTransaction

costcost

.06.06

(.58)(.58)

.09.09

(.42)(.42)

1.001.00

PoliticalPolitical

conflictsconflicts

-.07-.07

(.56)(.56)

.32**.32**

(.00)(.00)

.36*.36*

(.00)(.00)

1.001.00

UncertaintyUncertainty

regulationregulation

.02.02

(.08)(.08)

.24*.24*

(.03)(.03)

-.09-.09

(.41)(.41)

.20.20

(.09)(.09)

1.001.00

SecuritySecurity

Property Property rightsrights

.02.02

(.85)(.85)

.24*.24*

(.03)(.03)

-.04-.04

(.69)(.69)

.082.082

(.49)(.49)

-.07-.07

(..55)(..55)

1.001.00

PredictabilityPredictability

Of lawOf law

.33**.33**

(.00)(.00)

.09.09

(.43)(.43)

-.25**-.25**

(.02)(.02)

-.10-.10

(.37)(.37)

.03.03

(.77)(.77)

.18.18

(.01)(.01)

1.001.00

IncentiveIncentive .44**.44**

(.00)(.00)

-.00-.00

(.99)(.99)

-.36**-.36**

(.00)(.00)

-.14-.14

(.23)(.23)

-.01-.01

(.91)(.91)

.20.20

(.08)(.08)

.56**.56**

(.00)(.00)

1.001.00

•Correlation is significant at the .05 level (2-tailed), ** Correlation is significant at the .01 level (2-tailed)

Policy AgendaPolicy Agenda

More researches of NIE apply to the state:More researches of NIE apply to the state:

Continue predatory government?Continue predatory government? Builds on principal-agent models on new Builds on principal-agent models on new

institutional economics apply to tax systeminstitutional economics apply to tax system Builds stable, predictable, and credible Builds stable, predictable, and credible

“rules of the game” in PFM reform which may “rules of the game” in PFM reform which may affect the overall performance of an affect the overall performance of an economy, both in the short run and long runeconomy, both in the short run and long run