chapter nine Short-Term Adjustments In Public Expenditures

A. Premchand
Published Date:
March 1989
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One side will make you grow taller, and the other side will make you grow shorter.

LEWIS CARROLL, Alice's Adventures in Wonderland

Traditionally, the role of government expenditures was examined in terms of their contribution in fighting recession through stepped-up outlays on public works. With the persistence of high rates of inflation and recognition that public expenditures have, in part, contributed to the continuing crises, on the one hand, and compulsions of growth and antirecessionary policies, on the other, more importance has been attached to the upward and downward movements of expenditures over the short and medium terms. To be sure, changes are taking place all the time in government expenditures, but the specific issues relate to the role of expenditures in demand management and the extent of the stimulus to be provided or the restraint to be exercised. What tasks are inherent in this exercise? How do expenditures affect the economy and the living standards? Although changes in expenditures influence vital aspects of the community, the literature has been quite meager on these subjects. Studies in economics have mostly considered compensatory policies and the efficacy of public works programs. Public administration approaches, as revealed in occasional government reports, have been more concerned with the need for stability in expenditure and consideration of the delicate relations between the central and spending agencies in making expenditure adjustments. The lack of literature, which in the event is inversely related to the importance and impact of government expenditures on the community's welfare, may have, in part, been due to the feeling that the subject is a part of the arcana of government functioning. This chapter considers theoretical and other pragmatic approaches to the role of expenditures, to the problems of adjustment of expenditures, to the specific issues faced in making adjustments, and to a discussion of the issues in increasing and reducing expenditures in the short and medium terms. The chapter is primarily concerned with the financial aspects. While the political aspects are important, it is assumed that some broad choices have already been made on the character of adjustments.

Role of Expenditures

Public expenditures were for a long time considered as potentially powerful elements in managing total demand in the economy. But their use was resisted until the late 1960s, in view of some theoretical and practical considerations.1 Important among these considerations are the theories offered by Musgrave2 in the late 1950s, and the practical, public-policy-oriented recommendations of the U.K. Plowden Report Committee in the early 1960s. As both views had influenced public policies, it is appropriate that they are considered in detail. Musgrave's conceptual framework consisted of the allocation, stabilizarion, and distribution branches. The allocation branch is a balanced one and changes only with shifts in the preferences between government and private goods. The stabilization branch is not in balance and may have deficits or surpluses in accordance with the state of the economy. The distribution branch is balanced by taxes and transfers. Within this framework, Musgrave believes that changes in the amount of public expenditures should not be used to stabilize aggregate demand. This view is in conformity with his general framework in which the amount of public services is determined by the willingness to pay and where the community's preference is revealed through the voting mechanism. A logical extension of this approach is that, if the community does not want a service, the option is to change the government. Insistence on this framework would, however, mean that expenditures cannot also be used to stimulate demand during the low phase of the cycle. Musgrave believes that public works expenditures have no place among efficient services but are to be preferred to a “do nothing” policy. Conversely, it is also wasteful to cut expenditures because of inflation. The principal concern of Musgrave is to maintain the proper [emphasis added] amount of public services, which in his framework is there to begin with [emphasis added] through the voter's preference. He, therefore, argues that expenditure changes are not required unless it can be shown that consumer demand for social needs varies over the period of the trade cycle. Both these contentions are debatable. If the criteria for changing public expenditures is only through the community's demand for social services, it would be possible to use government expenditures as countercyclical instruments only when the requirements of stabilization policies are internalized and revealed through the voter's preference. However, given the market imperfections and gaps in information, the voter's preference cannot be expected to fully reflect the complex requirements of stabilization policy nor, in a practical world, would it be possible for the government to wait for the preferences to be revealed. Stabilization is a governmental role, and it cannot be fulfilled in the mechanistic style that the Musgravian framework implies. Moreover, Musgrave specifies a proper level of public services. In reality, the level is not immutable but has been changing over the years, reflecting the undercurrents of social philosophy and the voter's preference. The important considerations in public services are how much and when. Both these issues remain unanswered in Musgrave's framework. However, it should be recognized that the relatively recent phenomenon of persistent high rates of inflation and the government's own possible contribution to that were not evident in the late 1950s when Musgrave formulated his analytical framework.

If Musgrave's framework implies unchanged, perennially stable public expenditures, Plowden's demand for stability in expenditure was proposed in an environment in which there was too frequent “chopping and changing,” in which policy directions were blowing “hot and cold,” and in which the remedy was “worse than the disease.” The Plowden Committee felt that these changes in the level of expenditures impaired cost consciousness and financial discipline in government, that they frustrated efficiency and economy in public services, and that on the whole short-term economies in public expenditures were rarely successful and sometimes damaging and it was best they be avoided.3 To remedy the situation, the Committee suggested that stability of expenditure policy formulated in terms of maintenance of aggregate public expenditure aligned with prospective resources would have beneficial effects on the working of the spending departments by encouraging a “firmness of judgment and lucidity of criteria and priorities,” The Committee, despite its decisive thrust for a stable expenditure policy, recognized that some changes in government expenditure were inevitable but hoped they would be small but significant and timely. Subsequent experience, however, indicates that while the implementation of the Plowden Report established a medium-term planning pattern, stability in expenditure could not be attained partly for lack of political support and partly because of changing economic climate.4

Changes in economic events brought about changes in government approaches to public expenditure, as the traditional reservation of using public expenditure policies to help manage overall demand had yielded in the short run to more flexible approaches. Two factors contributed to this change in the perception of the role of public expenditure. The primary one was that the significant growth in public expenditure and the persistence of inflation had contributed to the view that if inflation were to be reduced, a beginning had to be made by reducing government expenditures. Second, it was recognized that the public sector could no longer be insulated against the burden of adjusting its own operations, leaving the onus of adjustment entirely to the private sector. These changing views led to the search for new control mechanisms and to variations in public expenditures as instruments in both phases of the trade cycle—to add stimulus to demand and to restrain demand through increases and reductions in public expenditures. The “inviolable” character of public expenditures fell a victim to the economic developments in the 1970s. These changes, in turn, generated new issues for budgeting and expenditure controls.

Dilemmas of Adjustment

The events in the 1970s reaffirmed the important role of fiscal policy as a major instrument of contracyclical policy packages. The choice, however, is whether short-term changes in policy are to be achieved through changes in tax rates or through changes in expenditures.5 The debate has, over the years, acquired active proponents who support primary or exclusive reliance on tax rates both by virtue of their technical superiority and also because of what are perceived as difficulties in expenditures. While difficulties—apparent or real—in reducing expenditure are considered below, it must be recognized that reliance on taxation implies a shift in the burden of adjustment to the taxpayer, whereas reliance on expenditure adjustment causes the burden to be shared by the government and the private sector.6 Those who question the inconvenience of cutting back government expenditures do not seem to be particularly sensitive to the burden of reducing private expenditure.

Supporters of tax change argue that tax increases or surcharges lead to reductions in demand throughout the economy without creating distortions in specific programs that expenditure cuts might imply, that tax cuts might be more appropriate for stimulating the economy, and that, in any event, taxes offer ample steering room in the budget to meet short-term policy goals. The effectiveness of the tax system is, however, dependent on the features of the system, the element of progressivity, the coverage and basis of taxes, and the efficiency of the tax collection machinery. Developing countries with a tax ratio of less than 20 percent of GNP that rely extensively on indirect taxation, or that exempt major sectors of the economy such as agriculture from taxation, would have only limited facility in the use of taxation. In countries where budget revenues are primarily dependent on a single mineral source, the flexibility is negligible and, in any event, private sector incomes are mainly dependent to a major degree on government expenditures. Thus, pragmatic considerations indicate that the package of fiscal measures, which are largely derived from the basic features of taxation and expenditure, should not be exclusively reliant on a single source but should require an appropriate combination of both revenues and expenditures.

The dilemma of the exact choice and the combination of the relative roles of taxation and expenditures is also based on the role assigned to the private sector. Regrettably, however, the impact of government operations, particularly expenditures, on the private sector and the relationship between government and private sector in the provision of social services have not been examined in any detail in the literature. Discussion has tended to be full of assertions that reveal some asymmetry in reasoning. The role of public expenditures in stimulating economic recovery is generally accepted on the premise that, even if development by private enterprise is preferable, there is no reason to believe that it would perform the tasks associated with economic recovery. Indeed, if it had been so capable, it would have prevented a recession. On the other hand, when the general phenomenon is inflation, it is suggested that government should cut back and that private enterprise should be allowed a greater role in the provision of goods and in satisfying social needs. While reductions in government expenditure are justified insofar as they are contributory factors to the cycle, it is not so certain that they can be used for assigning a greater role for the private sector. Such an enhanced role may, however, be justified in terms of the political philosophy, and in a particular phase of the cycle. Yet another factor that merits recognition is the type of complementarity that exists between the government and private sectors in the social services sector. Specifically, in regard to medical services, health, and education, both government and private sectors provide services to the public. In some cases, both make concessions for lower-income groups, although it is generally believed that it is only the government that offers such facilities. In principle, for certain sections of the community, private care and support may often be alternatives to public care and support and different social services may be substituted. The impact of reductions in government expenditures on sustaining social services is very complex and little is known about it.7 Reductions in public housing may be compensated for by increasing private amenities and similar substitutions could take place in other sectors. Thus, in aggregate, reductions in government expenditures may not necessarily imply drastic consequences for the level of services. But the differential impact of government and private programs would be different for various income groups. It could also be argued, although without an adequate empirical basis, that private services may be relatively cheap, as public services tend to become more expensive during an inflationary phase, while in the private sector, with greater attention on costs and emphasis on acquiring shares of the market, they could be less expensive. Such logic would be considered specious, particularly when the implication is that the private sector would miss an opportunity to increase its profits. Regardless of the private sector's behavior, the issue is its role both in terms of sharing the cost of adjustment (increased taxes) and in greater provision of services in some sectors (greater investment). This dilemma cannot be satisfactorily resolved as a technical fiscal matter alone and is to be seen within the wider context of the prevalent political philosophy. The choice of the instruments—taxes or expenditures—depends on the much larger choice of the role of the state.

Public Expenditure Adjustments

The role of fiscal policy as a countercyclical strategy involves both upward and downward movements in public expenditures. In regard to the increase in expenditures to stimulate demand, there is a fundamental difference in the technical approaches of developing countries and industrial countries. In the former, it is viewed as a structural problem and development plans are evolved to create the appropriate growth opportunities.8 In industrial countries, the aggregate demand is maintained through automatic stabilizers and through public works programs to compensate for the decline in the private sector's activity. The built-in stabilizers comprise unemployment doles, transfer payments intended to alleviate the burden on certain classes of people, and social security payments. These mechanisms are automatic and workers become eligible for payments from government soon after they become redundant in industries. If the period of the cycle can be forecast with reasonable accuracy, then governments can initiate action through budgets to minimize the cyclical impact.

Depending on the likely duration of the trade cycle in industrial countries and the different phases of growth in developing countries, plans and budgets are formulated for the medium term for increases in expenditures. These operations become more complex when they have to be carried out within shorter periods. Changes in the economic climate that, in turn, require proper responses from the budget are basically of two types. First, changes in the economy are recognized in advance and appropriate policy revisions are made in the budget. Second, changes take place in the economy after the budget is presented, thus negating the premises on which the budget has been formulated. To meet the new situation, a minibudget or a series of measures would be needed to correct the course. The first type presents few problems for budgeting as the issue is recognized and the budget content changed. The second type poses intractable problems and could involve reversals in policy directions. Some revisions may be carried out within the existing budget framework, while others would need changes in the economic basis and the relevant budgetary law. The burdens of adjustment differ depending on whether the proposed action is for increases or reductions in expenditures. While increases in expenditures do have implications for mobilizing additional resources, there is a widely shared belief that it is a feasible course of action. Reductions in expenditure, however, were often considered not only unwise but infeasible. From a budgetary point of view the problem has been considered with an attitude that borders on being defeatist. These considerations range from philosophical to institutional and operational, all of which factors merit consideration.

The philosophical considerations emphasize the community's own anticipations about continued services and the political acceptability of the sacrifices involved in reduced expenditures. Dahl and Lindholm point out that government expenditures mean that “services are performed, values are realized, administrative organizations developed, expectations expanded, clienteles formed, interest groups created, pressures mobilized, and once these are set in motion, they cannot easily be contracted.”9 These arguments were advanced at a stage when the imperatives of a welfare state were to further expand its services. In contrast, the growing tax burden, as well as what is perceived to be the inefficiency of government, has brought another view of the role of government. It is undoubtedly true, however, that in the traditional world the community's expectations have been considered linear. Views may vary if there is an option between greater burdens or greater benefits, which illustrates the basic fact that there are no immutable laws that govern expenditure increases and reductions and that the considerations are more pragmatic and dependent on the state of the economy and the level and components of public expenditure.

The institutional hurdles to reductions in expenditures are associated with the features of the budgetary system. First, a major problem in Latin American countries and similar areas is that a substantial portion of the budget is earmarked. Although the incidence of such earmarking is far from uniform, there are other similar arrangements that reduce the effectiveness of the annual budget. In addition, most budgets have sections of expenditures that are not subject to annual appropriations and are therefore beyond the budget review. Second, anticipation of changes in the economy would require a reasonable system of forecasting. As noted in Chapters 7 and 8, facilities in this regard are still at a nascent stage in developing countries. The facility in forecasting has a direct impact on the use of the budget as an instrument of contracyclical policy and to the extent that likely events are not anticipated and corrective action initiated, the problems of adjustment of expenditure tend to be compounded. Conversely, the existence of a forecasting system would, in due course, provide the authorities with flexibility to vary the parameters of fiscal policy. Third, governments may not often be endowed with freedom to move budget outlays and receipts in either direction, except with the approval of the legislature. Several contingent powers have, however, been given in recent years to governments to vary indirect taxes within limits. Expenditures reveal more varied experience. As noted previously, budget estimates as approved by the legislature imply a negative commitment in that no sums above the authorized amounts would be spent by the government. There is no positive commitment for it to spend the amounts. Technically, therefore, governments have powers in certain situations to restrict spending. But in countries such as the United States, where annual appropriations imply a greater commitment to spend, the presidential authority to impound spending is somewhat restricted.10 In some countries, unspent amounts constitute reserve amounts and the spending departments have a claim on them. Even where governments are endowed with appropriate authority, reductions in expenditures would not presumably be attempted for fear of public reaction. Such views are, admittedly, reflections on the use of power rather than on institutional rigidity, which itself varies depending on the legislative system. Fourth, a major institutional bottleneck is that the responsibility for fiscal policy is often with the central government, but the latter's ability to achieve any success is dependent on the spending patterns of its agencies, particularly public enterprises, and other branches of state and local governments. Often, however, other levels of government may show a fiscal perversity and spend more when restraint is needed or less when stimulus is indicated. Although coordination devices between branches of government are evolved to meet a broad range of functions, lack of explicit coordination for fulfilling fiscal policy aims may thwart the achievement of reductions in expenditures. (To some extent, this applies to increases in expenditures too, but, in general, increases have met with greater compliance than reductions.)

The operational factors reveal yet another problem area. Budgets in some countries are adopted by the legislatures with reference to the new contractual commitments that government departments can make. These contracts have long lead times and reversals are difficult. Budget outlays represent heavy commitments already made and cutting back these outlays, apart from being operationally difficult, is considered to be economically inefficient and costly. The implementation of projects, in order to be efficient, may require assurances of continuity in budgetary allocations. Also, the planning of reductions and their implementation takes almost a year and it is felt that either the phase of the cycle would change within that period or the required measures may be taken in the next budget.

Combinations of the above factors have gathered additional strengths during recent years. As a result, expenditures have tended to be classified into natural and artificial,11 controllable and uncontrollable,12 and expenditures that can be changed by administrative process and those that involve changes in law.13 Implicit in these classifications is the assumption that government expenditures are rigid and cannot be reduced in the short run. In support of this general approach, more arguments are advanced by governments. It is suggested that each time additional expenditure is undertaken to combat recession, the probability is that outlays will be racheted upward, as such increases prove rewarding to groups of individuals or sectors participating in the process. Most.outlays, particularly outlays for maintenance, which tend to move upward with additional capital outlays, would be difficult to reduce as a majority of them have little to do with the cyclical state of the economy. In addition, transfer and entitlement payments tend to increase with inflation and their automaticity cannot be eliminated. Viewed from this angle, it is suggested that the annual element of flexibility in the budget is about 3 percent of the total, which may not be significant if countercyclical strategy is to be successful. Even if expenditures are reduced, it could prove to be a measure of false economy in the short run, for in the long run expenditures on maintenance and personnel emoluments will catch up and will lead to more significant increases.

These views, which in a way have formed into a lobby, imply that once expenditures are incurred, that fact alone is adequate to allow their perpetuation. A closer examination of the issues suggests that “uncontrollability” has been used as a convenient alibi for inaction. The classification itself is arbitrary and, as an accounting distinction, it is not too clear whether its contribution has been anything more than a disservice. Clearly, extraordinary changes in the economy would require other than ordinary measures. Technically the law can take away, in whole or in part, what it has given.14 Therefore, the key issue is in terms of contribution and the role of expenditures in countercyclical policy. Denial of the role would provide a built-in growth in expenditure and would work as a destabilizing force whose impact cannot be neutralized even with a potent tax system. When the government budget is the primary contributor to destabilization, there is little reason to expect that it can be corrected by the tax system alone.

Formula Flexibility

Fiscal policy formulation in general and specifically in relation to stabilization has been frequently characterized by three lags.15 First, there is a recognition or identification lag, which refers to the quality of economic intelligence and reporting available to the decision maker, time taken in collecting additional material needed by him, and the quality of forecasting. Second, there is the administrative lag in that considerable time is taken to formulate policy responses. The administrative lag also includes the time taken to implement the formulated policy measures. Third, there is the legislative lag in that the legislature may take more time either because of the deliberation process or reluctance to make changes and approve the policy packages of government. Although this lag may not show the legislatures as they wish to be seen, it appears true that delays occur and that these could hamper the advantages to be gained in the proper timing of expenditure adjustments. As these lags make the budgetary process less effective, it was suggested that an arrangement whereby changes in taxes and expenditures to meet specific types of developments in the economy be legislated in advance, offering in effect a viable program that could be launched without loss of time. This formula flexibility is an automatic pilot that is tailored to structural relationships of the economy and its dynamics. Its main advantage is that it reduces the time lapse between recognition and administrative lags and would reduce the discretionary action to narrower limits. While, in theory, this approach has considerable appeal, its transition to the real world is more problematic. In the first place, evolving a formula that will initiate appropriate action is difficult. It requires clearly defined choices and objectives, sophisticated modeling, and a comprehensive grasp of all possible configurations of the economic future. The approach also assumes that stabilizing action can always be prescribed in advance, although in reality what matters is the degree of adjustment. If formula flexibility is available in full measure and if the formulas are perfect, they would absolve the policymaker from any discretionary action. In practice, however, there is a role for the policymaker as he has to distinguish between legitimate and false signals and the trade-off among options (e.g., unemployment versus inflation) and make necessary changes in policy. Although there are difficulties in achieving formula flexibility, the very search for a formula also suggests that consideration be given to an ideal framework in which government budgetary policies could be formulated. In considering the features of such a system, it should be noted that the search for a formula has in some measure contributed to the introduction of automatic stabilizers during periods of recession and to the provision of contingent powers to governments for taking action pending legislative approval.

The ideal system can be said to have four features, some of which characterize the budgetary process itself. First, the economic and social objectives and the priorities of government should be clearly stated. Both original budgets and changes have to be evolved within this framework. Second, the budgetary approaches should be specific not merely at the macrolevel but also at the microlevel. Third, adjustment in expenditures presupposes the existence and easy availability of detailed information on projects and programs, their legislative and funding status, their present stage in financial and physical terms, the time lags between construction and the beginning of the flow of benefits, and the impact of outlays on demand. These data enable the formulation of policies fully recognizing the impact and effectiveness of the different categories of expenditures. Fourth, flexibility in the traditional system has been limited to stabilizers during recession. Some payments are linked to the price indices that automatically trigger additional government spending. As a reverse of this proposition, it could be envisaged that these payments should have trigger clauses requiring fresh consideration after expenditures reach specified limits. This ideal system is certainly not in position in governments. Indeed if it were available, expenditure adjustments would be undertaken in a routine way and formulation of countercyclical fiscal policy would not be an issue. However, as the actual systems vary from the ideal, as is to be expected, suitable bridging measures in the form of planning the adjustments are needed.

Planning Expenditure Adjustments

Planning public expenditure adjustments is technically seen as a process for determining the increases and reductions in government expenditures in the short term to reflect sudden changes in economic conditions. Short-term adjustments should not imply a sacrifice of the future for the present and need to be planned to avoid such events. Although in the abstraction of economic models annual growth of government expenditure is largely considered to be discretionary, the policymaker will find that in the real world it is a vastly exaggerated notion. His flexibility or lack of it should not be seen as matters that are to be taken on faith or trust but are to be ascertained through an actual survey of the changes in conditions and the consequent changes in the budget. Adjustment of expenditure implies that a reallocation of resources in a form different from the pattern in the budget is needed. It also implies that reallocation requires to be taken as seriously as the first exercise. There cannot be one set of rules for allocation and another for reallocation or that the latter should become an innocent rite but that it should stand the test of scrutiny as the first exercise. The changes in the budget may be needed prior to its submission to the legislature but after the formulation has been completed, or any time during the period of the validity of the budget. In planning the adjustments, there are considerations of a broader, as well as of a specific, type. Included in the broader framework are the constraints that are to be recognized formally and explicitly. For example, it is necessary to recognize at a policy level that the alternative to expenditure adjustment is not a deficit financed by money creation. Also to be recognized are the lags between the introduction of corrective action and the emergence of their effects, so that the precise period of the timing of the impact can be pinpointed. Measures may have to be taken over a period and efforts have to be made to ensure that measures calculated to balance one budget do not lead to the unbalancing of the next. It is necessary to ensure that there is close coordination and consultation between central agencies and spending departments, for without these the latter may be tempted to resort to escape mechanisms. These mechanisms need to be anticipated and regulatory and control mechanisms strengthened to avoid their occurrence. Further, short-term changes should conform with the long-term objectives and should, in any event, be an aberration with minimum hindrance. Without such conformity, changes in expenditures will be indiscriminate and will distort the process of growth. At the same time, closely coordinated functioning between plan and fiscal action should not mean that long- or medium-term plans should be rigid. The magnitude of adjustment is also important. If the order of variation of expenditure is low, it is unlikely to have any impact on the economy and the whole effort has the potential of becoming one of misdirected energy. The considerations involved can be presented in the form of a planning matrix showing lateral as well as vertical considerations of expenditure adjustments (Table 14).

Table 14.Planning Expenditure Adjustments: A Framework
Relevant Variables

Functions and

programs (e.g.,

Nature of

Duration of

Relevant total


including earmarked

and other funds
Magnitude of


impact on

the Plan

and change in


of service
Consumption Expenditure
Wages and salaries
Other expenditure
Capital Formation
Land Buildings
Transfers to other levels of government
Transfers to households

The aim of expenditure adjustment is to exercise deliberate influence on the final aggregate demand in the economy through subtle or significant variations in expenditure. In choosing between various courses of action, the differential multiplier or withdrawal effects of public expenditures need to be carefully reviewed. For this purpose, expenditures are reclassified (Table 15) in terms of their content and influence. If expenditures are merely increased in transfer payments, little will be accomplished if the real need is to increase investment outlays. Planning expenditure adjustments cause the composition of expenditure to change. It is particularly necessary to take into account the paradoxical effect of some types of expenditures. A notable effect is that, as a result of austerity measures in the budget, more people become unemployed and then they become entitled to unemployment benefits provided as part of the social security system. As the number of unemployed grows, transfer payments increase and, eventually, overall expenditures may be higher than anticipated and will also claim a higher share of GDP in a stagnant economy. To that extent, government deficits tend to be higher and continue to fuel inflationary pressures.16 Yet another effect is that cuts in capital expenditure adversely affect growth, in turn contributing to reduced revenues and larger deficits. Also, higher unemployment means reduced revenues. These aspects incidentally illustate the complexity of expenditure planning and the futility of any search for formula flexibility.

Table 15.Planning of Expenditure Adjustments: Classification of Expenditures
1.Predetermined expendituresComprise interest, debt repayment, subscriptions, etc., and do not lend themselves to increases or reductions
2.Regular expenditureReflects outlays including some transfer payments incurred on current or ongoing policies. Reductions are possible through policy adjustments. In planning increases, new programs often present problems in projecting the rate of spending
3.Expenditures that could be modified in the light of desired government influenceReflect outlays of an investment or development character, including public works that could be adjusted in either direction
4.Expenditures dependent on economic climateOutlays on subsidies, price supports, etc., which may be based on specified economic indicators. Outlays could ideally have trigger clauses so that consideration is given to policy options after a critical stage is reached
5.Demand-dominated expendituresLending and related operations by government are included in this group. The importance of this group depends on the magnitude and purpose of lending1
6.Contingent expendituresCover contingent liabilities incurred through government guarantees. Such outlays are relatively rare and unpredictable

In some countries where lending is used as an adjunct to spending to further governmental goals, outlays of this type could be sizable.

In some countries where lending is used as an adjunct to spending to further governmental goals, outlays of this type could be sizable.

Planning for increases in expenditure has had a long history since the Depression. Various budgetary techniques were used during, and have been used since, the Depression to formulate a contingent “shelf” of projects that could be initiated with little lag. Medium-term planning implies a capital expenditure program intended to stimulate aggregate demand. As noted earlier, the information demands of such programs are quite high and involve not “boiling pot” arrangements of an ad hoc nature but a more formal approach toward contingent planning. The important point to be noted is that, while a “path” is charted in a development plan or a medium-term forecast, planning for short-term adjustments involves projects that could be introduced and terminated with greater ease. The emphasis is on the nature of the projects and on their facility for quick implementation. Options between projects, transfer payments, and tax cuts, and their relative efficacy, will have to be evaluated as a part of this planning exercise.

Reductions in expenditures involve the basic questions whether they are envisaged for existing outlays or for a reduced rate of growth of future expenditures. The former involves more drastic and quicker measures, while the latter is less painful. Reduction in existing outlays involves forgoing existing comforts and experiencing reduced public services, while a reduced rate of growth affects only expectations. In both cases, expenditure reduction is only one instrument of the package and its linkage with others has to be consistent.17 Adoption of supply economics approaches implies that more attention should be paid to the impact of expenditure reductions on the quality of economic life in general and on industrial and labor productivity through reduced subsidies and income transfers. A thorough program analysis would be required to test the efficacy of ongoing programs. Does the program achieve the goals laid down in the original legislation or in similar specifications? Are the original goals of the program still appropriate and, if not, could they be terminated without unduly disrupting the industry or groups affected by them? Is the total cost of the program commensurate with the benefits achieved? If there had been an increase in the costs, is it due to physical or price factors? What measures can be taken to check their growth?Do some of the more important aspects need to be faced frontally? Greater surveillance is involved of the ways in which expenditure controls are operated, the points at which control is exercised, and the agencies and officials entrusted with the responsibility for exercising them.

Planning reductions in expenditure implies a heavy leaning against the wind. Spending agencies, clientele groups, and others tend to think that their favorite program should be exempt from reduction.18 In pursuance of their objective, political pressures are applied and campaigns organized. In the process, some programs become “more equal” than others. While in the final analysis political views prevail, at a technical level it is more appropriate that objective criteria be applied. Otherwise, planning expenditure adjustments will degenerate into an ad hoc exercise of controlling what can be controlled and cutting what can be cut rather than what should be cut, and thus will be self-defeating. More important, this exercise adds to public skepticism about the government's seriousness in policymaking.

Expenditure Increases

Although the issue during recent years has not been to increase expenditures, it is instructive to consider the experiences of industrial and developing countries in developing budgetary techniques in this respect. A broad range of techniques and programs used in this regard are shown in Table 16. The principal budgetary innovation made during the depression years and followed since then relates to the introduction of general emergency budgets and extended grants in Nordic countries. Although there are variations on the themes among these countries, the purpose of the mechanism is to vote amounts and keep them for use without reference to the legislature. In Sweden, for example, the budgetary system has three instruments—General Emergency Budget, Relief Works Program in the Ordinary Budget, and a Contingency Reserve for Housing. All these are to be utilized for increasing expenditures to keep aggregate employment as high as possible during the cycle and to limit imbalances among regions and industries. The General Emergency Budget, with outlays voted each year equivalent to approximately 1 percent of GDP, represents an accumulation of a shelf of projects that could be launched immediately. To be eligible for inclusion, projects need to be in an advanced Stage of planning, so that work could begin at four months' notice. The provision for a relief works program is made in the ordinary budget, or through supplementary budgets that are presented at least three times a year, and certain authorizations for relief work in road transportation and on similar projects are included in the emergency budget. In regard to housing, the approved programs include a contingency reserve that might be used, if warranted, by overall economic conditions and the status of labor in the construction industry. In addition to these, extended grants provide additional flexibility. The experience of Sweden during the early 1970s shows that the General Emergency Budget was not used and that there was demand management mostly through relief works, housing programs, and increased investment by public utilities.

Table 16.Increases in Expenditures: Techniques and Measures
Nature of Budgetary TechniqueMeasures Covered
Supplementary budgets and contingency budgetsEmergency public works, large investment projects, increases in investment by public utilities, crash programs for employment of educated youth
Extended grantsFlexibility to spend beyond the fiscal year without further legislative approval
Cyclical equalizationRelease of funds to specified projects/programs from funds accumulated during periods of expansion

Conjunctural action funds or cyclical equalization reserves are used extensively in the Federal Republic of Germany. These funds are held at the Bundesbank and represent “excess” revenue (revenue that is in excess of the forecast because of higher prices and increased activity) transferred to a fund that is then used to finance expenditure during a downturn without having to resort to additional borrowing. (Part of these funds could also be refunded to the taxpayer.) Similar arrangements are found in other European countries.

The issues in increasing expenditures relate to the efficiency with which budgetary techniques are deployed and the effectiveness of the programs chosen for the purpose. It is not realistic to expect these programs to work with push-button efficiency; in fact, they need careful advance planning. The experiences of some industrial countries indicate, for example, that there is no easily accessible shelf of projects. Either because of this, or because of other factors, emphasis has shifted to programs whose main purpose is to distribute cash through training programs ostensibly designed to provide technical skills. The experience of oil exporting countries in the period after 1973 suggests that utilization of increased revenues took place primarily through stepped-up emoluments and other transfer expenditures. But such increases may bring more problems instead of stabilizing or managing aggregate demand. It is evident that undertaking judicious increases in expenditure is not as simple as it is often believed to be.19 The large shortfalls in such planned expenditures highlight the difficulties and stress the need for proper contingency planning.

Public Works20

The majority of projects and programs introduced for increasing expenditures comprise what have come to be known as public works. The concept underlying public works is not new and, in retrospect, may be ascribed to the extensive construction of forts and tombs by the Moghul rulers of India and of the churches built by Christian kings elsewhere. Public works have a variety of purposes and are used as a means of national development, as a stimulus to employment, and as a means of mitigating the crises. Both industrial and developing countries have made, and are making, extensive use of this policy package.21 The advantages of public works are that they can be designed to pay attention to low-income groups, are highly divisible, lend themselves to easy phasing and quick implementation, and, more significantly, their impact is visible. This is not, however, to suggest that all is well on the public works front. The experience of industrial and developing countries shows that the objectives of programs are rarely matched by end results. A major part of expenditure may be for payments to contractors rather than for labor. The impact of public works is obviously dependent on the magnitude of allocations and the financial priority assigned to them in the policy package. Often, however, pork barrel considerations appear to have a decisive influence on the location of public works and, because of lack of advance planning, amounts end up being spent on unproductive projects. With a more careful choice of projects, technology, and implementation agencies, it appears that more durable results could have been achieved. Especially in developing countries public works have tended to be concentrated on minor irrigation repairs that are ephemeral in nature and are lost with the onset of the monsoon. It is frequently suggested that there is not much perseverance in the public works efforts, and that more lasting benefits could be obtained through comprehensive operational planning.22

Reduction in Expenditures

The techniques used for reducing expenditures and the measures typically covered by these techniques are shown in Table 17. The approaches to reduction in expenditures may be analyzed in terms of the techniques adopted, functional categories of expenditure affected, the economic categories of expenditure involved, spending agencies that have a prominent role, and the impact of reduced expenditure on the distributional goals of government.

Table 17.Reduction in Expenditure: Techniques and Measures
Nature of TechniqueMeasures Covered
Across-the-board cuts in expenditures; rescissions1General percentage cuts in all activities of government
Specific sector cuts: impoundment of funds2Reduction in expenditure of specific sectors
Selection of quick-yielding projectsIn the context of a resource squeeze and related imperatives for reduced expenditures, reliance is placed on projects that have low gestation periods and quick revenue feedback, in preference to those with longer gestation periods and delayed revenue yield
Reduction in expenditure on personnelReduction in administrative posts and not filling existing posts
Quarterly cash management budgets: cash limits and other adjustment mechanismsRelease of quarterly apportionments to spending agencies so that they are within limits of specified resources. Adjustment within those ceilings is a matter for the spending agencies to decide

Rescissions as a technique is found in the United States and refers to proposals by the President for repeal of the previously enacted provisions.

Impoundments—again to be found in the United States—refer to executive impoundment of funds authorized by the legislature.

Rescissions as a technique is found in the United States and refers to proposals by the President for repeal of the previously enacted provisions.

Impoundments—again to be found in the United States—refer to executive impoundment of funds authorized by the legislature.

It is a common experience that most governments are endowed with powers to reduce expenditures, although such powers are somewhat more straitjacketed where legislative involvement in the budgetmaking is greater. In a British commonwealth country, reductions in expenditure can be undertaken by the executive. In the U.S. type system, the President did have the power to impound outlays approved by the legislature, if so desired, for purposes of achieving fiscal balance in the economy. This was, however, altered after the introduction of the Congressional Budget procedures in 1974. In other countries, notably in the Federal Republic of Germany and France, where powers were lacking, appropriate delegated authority was given during recent years. For example, under the Economic Growth and Stability Act 1967, the German Finance Minister was empowered to freeze the use of certain funds, the commencement of construction work, and commitments for expenditures for subsequent financial years. He can also place limits on borrowing by Laender (state) governments. Certain other types of expenditure could be incurred only with the prior approval of the Finance Minister. In France, another technique (which is a reversion of the cyclical equalization reserves in Germany noted earlier) was experimented with in the late 1960s and was abandoned after a few years of experience. Under this procedure, the Government froze part of the investment authorizations and set them aside in funds for action (fonds d'action conjuncturelle). The funds, so separated, could be activated when there was a need to stimulate demand. In developing countries, finance ministries generally have powers to issue directives, abandon programs, or reduce outlays.

A common technique (variously known as an emergency brake or meat axe budgeting) used by governments is across-the-board cuts; this technique implies that all expenditures are treated equally.23 Over the years the use of the approach of across-the-board cuts has gained adherents and those who are strongly critical of the method. Among those who support it the technique is considered to be a fairly simple operation, it implies a fair share of adjustment to all, and it will bring a new level of equilibrium from which expenditures may grow. Implicit in this approach is the belief that there is a degree of slack in the existing level of operations, which, if removed, would not in any way reduce the efficiency of expenditures. Also implicit is a faith that somehow, once the shock is administered, things will work out largely through the working of the invisible hand. To the critics the technique is a negation of all budgeting and the manifestation of a refusal to admit realities. The simplicity of administration of the technique is deceptive and works adversely against spending agencies that have been provided with reduced allocations to begin with. The fair share thesis is also considered to be inappropriate. As the Plowden Committee reported “if any increase or decrease is required in the total Government expenditure, therefore, the only sensible course is to decide to treat the Departments unequally.”24 Also, to the extent there is a slack, it is most likely that its incidence will be more differential than uniform. Given that the impact of inflation on the finances of departments is not uniform, it is difficult to perceive that equal reductions in expenditure would be a solution. The more significant impact of across-the-board cuts implies, at least in the perception of the public, that quick cuts can be made, although in reality nothing is being reduced but only partly postponed. Moreover, in the practical world, use of across-the-board cuts may degenerate into centralized financial controls that tend to work in arbitrary, uncertain, ad hoc, and personal ways.25 The alternative to this is specific sector cuts, which imply the selection of programs that can be and need to be cut.

Yet another technique, much emphasized but actually less used than its full potential indicates, is the selection of quick-yielding projects and programs. Implicit in this approach is the belief that if projects with shorter gestation periods are chosen, they would make a quicker contribution to government revenues and that the pressures on government finances would be reduced. The use of this technique would ideally be reflected in the development strategy and annual budgets. By its very nature, this technique has greater relevance to developing countries. Experience indicates, however, that the policy emphasis on quick-yielding projects is not always accompanied by the introduction of budgetary techniques for identifying such projects, either in the financial planning stage or during the formal budgetary process. Even where relevant techniques have been used, their impact was not discernible because of the relatively negligible revenue yield, on the one hand, and the general increases in expenditure stemming from policy factors, on the other.

Other techniques used offer a variation on the theme of adjustment within given ceilings. Quarterly cash budgets under which apportionments are conveyed to departments, the system of cash limits (in the United Kingdom), and the envelope system (Canada) belong to this category. More recent variations of this approach are the “scrap and burn” technique in Japan and “tit for tat” in New Zealand, both of which imply that departments cannot seek expenditure increases and that if any increases are to be made they should be within the specified ceiling and taken up only in lieu of existing programs. The implementation of these approaches reveal a twofold difficulty: (a) in some cases, because of the exclusion of some functions from the budget and consequent limited coverage, the effectiveness of the system was reduced, and (b) spending agencies had to adjust their priorities within the allotted amounts, which was found to be difficult in the absence of a detailed framework of governmentwide priorities. These drawbacks should be seen more as areas that need further refinement. Yet another approach is to place increased emphasis on reviewing the existing programs to secure efficiency. The British practice of “scrutinies,” initiated by Sir Derek Rayner in 1981, seeks to question the need for a program and the way it is carried on. Similar practices were adopted in Sweden as well. Essentially, however, this reflects an extended use of evaluation techniques that gain greater acceptance during tight economic situations.

Functionally, the experience of industrial and developing countries shows that the axe can fall on social and economic services, while outlays on security and related general administrative services are maintained. The axe on social services reflects a belief (a) that it contains many free services and (b) that reductions in government services may partly be compensated for by increases in the private sector's provision of services. Social services represent a politically sensitive area, and the areas chosen for the purpose are often directly dependent on the proportion of their fiscal influence. In a large number of developing countries, economies in expenditure are routinely sought through across-the-board cuts in nondevelopment expenditure in the hope that the savings so available could be used for development purposes. In reality, however, such savings prove to be illusory and, in the event, reductions may finally be made in development outlays.26 Reductions in capital and development outlays affect growth prospects and, as noted earlier, reduce the growth of revenues as well. Confronted with political difficulties for reducing existing expenditures, and also in view of the attributed rigidity of expenditure, governments have found it expedient to reduce scheduled outlays for capital purposes. The choice between development and nondevelopment expenditures is not a hard one from an economic point of view. When for political purposes the future is sacrificed for the present, it will be found out, before too long, that expedients demand a high price.

In terms of the spending authority, experience reveals that some agencies are selectively exempted from the operation of expenditure adjustments. Among those exempted are defense and development departments (for example, agriculture) in developing countries. This selective exemption implies a degree of “unequal” treatment, which is desirable.

From the viewpoint of the economic category, however, the two categories that are chosen for severe treatment are investment and personnel outlays. Investment outlays have been considered earlier. From the early 1920s onward, cuts in the pay of government employees and in personnel strength have been repeated and severe.27 The attention to personnel is only natural, for the lion's share of outlays is on personnel payments. But this is also an area that is more difficult than others in view of the security of employment and the frequent use of escape mechanisms by spending departments to circumvent the policies.

Expenditure reductions also lead to changes in the distribution patterns. A change in the functional and economic categories of expenditures imply changes in their relative shares and in their distributional impact. Such impact is to be seen among different income groups, between rural-urban parities, and among regions and industries. Although detailed studies are not available on the incidence of expenditure benefits on distribution, it is tautological that the first-round effects of expenditure cuts would be a reduction in employment, unless compensatory developments take place in the private sector.28 Much would depend on the sector in which cuts are made and the purposes of related programs. Reduction in medicaid, food stamps, food subsidies, cuts in services to remote areas all affect the poor or the specific areas for which the services were intended in the first place. Whether these effects in the distribution pattern are in conformity with the policies of government or whether they have been unintended effects of indiscriminate application of budgetary cuts is, however, a separate matter.

The implementation of the above approaches has been associated with problems. There is little need to reiterate that expenditure reductions will lead to increased inefficiency and reduced quality of services unless such expenditure controls are carefully planned and targeted to specific programs.29 Moreover, it is suggested by those who have been engaged in the formulation and implementation of austerity programs that easier options for reducing expenditure have been exhausted, that such reductions may be obtained only when first applied, that deferral of maintenance expenditures cannot be sustained indefinitely, that catch-up on restrained programs would lead to more expenditures in due course, and that new programs of expenditures are becoming evident. The agencies in government tend to think that their initiatives and enthusiasms have been unduly dampened. The central agencies caught up in the cross fire between spending agencies and the quest for immediate results in the context of financial stability are not often sure in which direction they are moving. The public, for its part, wonders about the significance and direction of expenditure cuts when they find hospitals with declining services and libraries with no new additions.

These puzzles are symptomatic of the difficult financial times and suggest the need for greater, rather than less effort, for strengthening expenditure planning and control systems. The whole process of control is a delicate one in which a balance must be sought between the need for financial stability and expenditure cuts, between excessive action that might affect the achievement of the overall objectives and the limited actions that might defeat short-term objectives, and between easier methods of affecting reductions and the more difficult choice of making planned cuts in areas that need to be cut. The situation demands an appropriate contribution on both policy and technical fronts and improvements in the processes. Expenditure planning would have to envisage the contingency of reductions and reversals of policies.30 A contingent plan of reverse priorities of programs and projects that could be withdrawn at short notice should necessarily form part of the strategy of the central agencies. These are to be planned in close consultation with the spending agencies to ensure compliance.

In the early 1930s European countries made extensive use of public expenditures in balancing budgets. For an interesting account of these experiences, see Hugh Dalton (1933), pp. 437–56.

See R. A. Musgrave (1959), pp. 517–20; and United Kingdom, Control of Public Expenditure (1961), pp. 8–10.

Similar views were expressed in 1974. The Expenditure Committee of the House of Commons noted “changes in the level of public expenditure should be used only as a tool of last resort, … it should be regarded as a confession of failure when changes in the level of public expenditure … are made and then reversed on a countercyclical basis” (United Kingdom, Public Expenditure, Inflation, and the Balance of Payments, 1974, para. 19).

See Peter Vintcr (1978), pp. 18–31.

Adherents of monetarist and rational expectations theories generally assert that variations in either government expenditures or taxation are ineffective for stabilization purposes.

Sir Douglas Wass (1978) noted “if the brunt of short-term fiscal policy changes falls on the tax side, the burden of adjustment falls mainly on the private sector. The consequent costs of disruption in the private sector may as well be as great as the costs of disruption in the public sector” (p. 100).

See Rudolf Klein (1978) for a discussion of these aspects with reference to the United Kingdom.

The Second Five Year Plan (1966) of the Government of India noted “in a developing economy the basic trend of governmental operations in the fiscal and monetary field is inevitably expansionist. Expenditures could be stepped up and credit made available in ampler measure should recessionary trends unexpectedly appear. However, the problem in the main is likely to be one of regulating inflationary pressures. Creation of new demands somewhat ahead of supplies is part of the strategy of development. It follows that a curtailment of public expenditure and other curbing devices can and ought to be used only in the last resort” (India, Second Five Year Pian, 1956, p. 38).

R. A. Dahl and C. E. Lindholm (1956), p. 362. It should be noted that government expenditures have not always grown and there were periods when they were reduced. Many colonies had experienced slashed budgets depending on the exigencies on the home front. For a detailed account of Indian expenditures prior to independence and the pressures to reduce expenditures, see A. Premchand (1966b), Chapter VIII; and Dalton (1933) provides an account of the international experience in reducing expenditures in the late 1920s and early 1930s. For a review of the recent Australian experience, see R. B. Scotton (1978).

During 1971–73, some impoundments were made by the President which were construed by the legislature as executive incursions into the legislative domain. Eventually, this contributed to the introduction of new budgetary procedures in the Congress in 1974.

See, for example, Murray L. Weidenbaum (1969), Vol. 1, pp. 357–68.

This distinction is used in the United States. Empirical surveys conducted on the approaches of budgeteers indicate that they would be reluctant to approach the uncontrollable outlays mainly for the reason that there is not much to be gained in reviewing them. Many agencies in the United States felt that zero-base budgeting (1976 onward) was not suited to uncontrollable programs. The surveys illustrate two points. First, the solutions to uncontrollable outlays lie in appropriate policy changes rather than in techniques of control. Second, the broad acceptance of some outlays as uncontrollable contributes to an atmosphere of accepting their inevitability. The gradual growth of this feeling tends to permeate the governmental process and, in the medium term, its impact could be more devastating than the influence of any vested interest.

The practice in Denmark and the Federal Republic of Germany.

The period prior to the onset of the depression witnessed some heavy reductions in expenditures to balance budgets. Strong measures were taken by Australia and New Zealand, among others, to reduce expenditures. See Dalton (1933), p. 450. Similar experiences are to be found elsewhere in less turbulent times,

Dalton (1933) recognized this problem 50 years ago. He wrote “the cost on public funds of maintaining unemployed workers, however low the level of maintenance, rises as their number increases” (p. 11). This phenomenon occurred in the United Kingdom during 1980/81 and expenditures were higher than forecast because of higher payments for redundancy (United Kingdom, Economic Progress Report, 1981).

The purposes of expenditure cuts may be negated by an easier monetary policy. The approaches have to be congruent for expenditures and monetary policy.

Writing about the Indian Government's efforts toward economy in expenditure, Sir Richard Temple observed “some who preach economy as a rule seem to think that a favorite project is to be the exception; the sense of its particular merits causes the general maxims to be forgotten” (India in 1882 (London: Macmillan), p. 449).

J. M. Clark (1935) pointed out that if programs and projects are planned in advance they cannot be put into operation at a moment's notice. It is not unrealistic to assert, however, that considerable progress has been made in this area since the 1930s.

T. S. Eliot wrote “A commission is appointed for Public Works, chiefly the question of rebuilding the fortifications,” Difficulties of a Statesman.

John Woodward Thomas (1974) points out that at least 15–18 developing nations, during the last two decades, have established special public works programs with employment as a primary objective (pp. 297–311).

Dalton (1933), p. 445–46.

Across-the-board cuts could be used at various stages of the budget formulation. For example, this approach could be specified in the budget ceilings indicated to spending agencies for formulating their initial estimates. It could also be used after the review and approval of budget estimates but prior to the submission of the budget to the legislature, if such changes are mandated in terms of reduced resource availability; these cuts could also be imposed after the budget has been approved. The reference here is to the cuts made after approval of the budget by the legislarure.

United Kingdom, Conceal of Public Expenditure (1961), p. 31.

The zeal and pleasures of “cutting” must be restrained. Otherwise indiscriminate cutting could prove a costly affair The history of the late 1920s would repeat itself. In Australia, for example, all expenditures, including interest on internal debt, were reduced, foreclosures stopped, and hire-purchase agreements reopened. This, however, adversely affected the borrowing operations of the Government. For an interesting account of this experience, see Dalton (1933), p. 441.

India had to drastically reduce its envisaged outlays for the fourth plan period owing to the failure of its general economy measures. See A. Premchand (1966a).

One of the areas subjected to economy in the 1920s was war pensions and allowances. There was considerable resistance for such cuts but eventually they were made (Dalton, 1933. p. 439).

For a brief and impressionistic study of three countries, see Omotunde Johnson and Joanne Salop (1980), pp. 1–23.

For a recent discussion of this issue with reference to the United Kingdom, see P. M. Jackson (1980), pp. 66–82. The author of this book argued for greater attention to soft spots in 1974, see A. Premchand (1974), pp. 27–30.

Budgetary systems in selected countries have already been reorganized for the purpose. In the United Kingdom, the Public Expenditure Survey System annually asks the spending agencies to indicate the programs that they can do without or reduce spending on; in Canada the “X” budget procedure routinely gathers data on programs that agencies would be willing to forgo in the event of reduced resource allocations. In the United States, the Zero-Base Budgeting System collects information from spending agencies on programs for which reduced allocations will be accepted. In some developing countries, notably Bangladesh and Tanzania, “core investment programs” with priority were identified for funding in case of resource shortfalls. Despite these built-in features, however, available evidence does not indicate that these have been fully utilized. A future need is to make these features of budgetary systems fully operational.

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