Chapter

2 Management of Public Money: Issues in Government Financial Management

Editor(s):
A. Premchand
Published Date:
June 1990
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Author(s)
A. PREMCHAND

INTRODUCTION

The management of government finances has been in a state of continuous development over the last four decades. This development can be traced largely to the changing tasks of the state and thus of the government. The changes were not merely in the style but also in the substance of economic management. Public money management practices have been seriously buffeted by the crosscurrents of changing economic conditions. Following the Second World War, budgeting appeared to have lost its traditional role of restraining public expenditure and came to be used for economic growth. More recently, after substantial growth in public expenditures and the ensuing fiscal crises, budgets once considered locked in had to develop a reverse capability to reduce expenditures and manage cutbacks without excessive distortions. Questions have shifted from “who is going to get more?” to “whose budget should be further reduced?” Between these extremes public money management has evolved from a practicing art to a still imperfect science. Although an analysis of this evolution (interesting in itself) is not attempted here, to provide an essential perspective to the discussion, Table 1 shows the evolution of public expenditure budgeting and the changing values and techniques of budgetary systems.

Table 1.Public Expenditure Budgeting
OrientationPurposes and FeaturesTechniques
Control(a) Ensuring legislative accountability

(b) Reducing expenditures or other growth rates
Line-item review
Management(a) Ensuring legislative in-depth accountability

(b) Ensuring value for money spent
Performance evaluation Performance measurement
Planning(a) Planning for growth on the assumption that resources are availableProgram budgeting
(b) Ensuring allocative efficiency through investment appraisal and exploration of alternativesPlanning, programming, budgeting systems; cost-benefit analysis
(c) Economic analysis of the impact of the budget

(d) Planning over an extended period
Various concepts and measures, ranging from structural budget margin to full employment surplus budget Multiyear budgeting
(e) Policy planning with an explicit recognition of resource constrainEnvelope system; reconsideration t procedures
(f) Budget planning in terms of different resource availabilitiesZero-base budgeting
Economic(a) Flexibility in government budgets that would compensate for fluctuations in the levels of private activity and that would ensure stability in the economyIncreases and reductions in expenditure through ad hoc measures or institutionalized mechanisms
(b) Management of the economyControls on overall deficit as percentage of GDP, or on borrowing requirements
(c) Containment of expenditures during periods of inflationCash limits
(d) General restrictions on expendituresConstitutional limits
Note: All the orientations, features, and techniques are somewhat related. But some techniques are more closely related to some orientations, and this aspect is illustrated above.
Note: All the orientations, features, and techniques are somewhat related. But some techniques are more closely related to some orientations, and this aspect is illustrated above.

The concerns of this paper are much more immediate: the cumulative problems in the broad area of government financial management, the issues inherent in the current situation and those likely to emerge, and the consideration of available alternatives. Another aspect of this paper deals with the systemic constraints that have tended to impede rather than enhance the implementation of fiscal policies. The paper does not deal either with the policies or with other features that could be considered assets of government financial management systems. To that extent, its coverage is selective. It does not aim to describe the systems, but to deal with problems that might be the agenda for government financial managers in the late 1980s and early 1990s. It seeks to be realistic, not apocalyptical. The first section sets out certain general facts and considerations relating to government finances in developing countries as a prelude to the detailed consideration of these problems. A discussion of the current status of the government financial management systems follows. Finally, the paper considers the areas that need addressing and how it may be done.

SOME FACTS AND CONSIDERATIONS

It is generally recognized that the government is the largest organization, employer, and spender in industrial and developing countries. The magnitude of its receipts and expenditures has no parallel in the private sector. More important, its operations have been growing over the last few decades. This growth is more pronounced in some countries. In a few countries, government expenditures have registered a decline as a share of gross national product (GNP). In developing countries during 1972–85, total government expenditures grew as a share of GNP by nearly 7 percent. The effect of such a growth was twofold: on the composition of expenditures and therefore on the financial management system; and on the overall pattern of government finances and thus on the economy.

In most developing countries—reflecting the larger role of the public sector—more is allotted either for direct investment or for lending and related transfers to public enterprises and other public sector entities. Growth in public spending, together with the change in composition, implies that, in considering the government financial management system, due attention has to be paid to its capability to reflect and respond to the changing requirements of the enterprises and entities dependent on public budget transfers. An associated aspect of both vertical and horizontal expansion of government activities has been a growing tendency to centralize policy and process controls.

The growth in expenditure was accompanied, in general, by a less than commensurate increase in government revenues, which in turn contributed to growing fiscal deficits. During 1972–85, developing countries’ fiscal deficits increased from 3.5 percent to 6.3 percent of GNP. As the scope for domestic financing was less in developing countries, they frequently resorted to inflationary financing and to external debt. In due course, both these policy pursuits contributed to steady and continuing fiscal crises. These crises and the approaches to minimizing and avoiding them have become dominant themes in the last few years. Since the overhang of these problems will probably continue, they will almost certainly continue to dominate the work of fiscal policymakers and government finance managers in the near future.

The fiscal crises themselves have had an enduring impact on the working of financial management systems in government. The main feature of the crises, which tended to permeate the whole process, was uncertainty—about allocation of funds, their availability, and their release. The ceilings and resource allocations indicated at the beginning of the fiscal year were adjusted downward during the year, and cuts were frequently imposed on an ad hoc basis and across the board. In addition, restrictions were imposed on inputs, which in turn substantially affected outputs and outcomes. Also, the payment process was frequently centralized, and, as a result of restrictions on payments to conform with reduced allocations, substantial domestic and foreign arrears accrued. More significant, decision making and operational responsibilities were centralized. Furthermore, the crisis management approach was not to anticipate crises but to deal with them as they arose, and consequently the policy guidance role of central agencies suffered. Moreover, as crisis management became the prevailing style, financial management systems received either benign or deliberate neglect.

CURRENT PROBLEMS

Problems in government financial management have been identified from time to time. Each time, however, the problems identified were different. In the late 1930s, they were primarily in the area of budget structures (division of government outlays into current, capital, and related aspects) and in the relationships between the treasuries or ministries of finance and the spending agencies. In the 1950s, they concerned the inherited colonial administration systems and the requirements of development planning. In the 1960s, emphasis shifted to the management aspects of government finances, and problems were identified in expenditure objectives (or the lack thereof), in the relationship between policies and their financial implications and between physical and financial aspects, and in the measurement of program costs, benefits, and effectiveness. These problems continued into the 1970s and can still be found, in differing degrees. Several new budgeting systems were introduced (for example, program, performance, and planning and the selective introduction of accrual accounting), as were other systemic improvements. However, the intention here is to cover the current problems.1

These problems cover a wide area and range from public expenditure planning to government accounting and financial reporting, as well as the control of public enterprises. The main problem areas in the systems, excluding those relating to public enterprises, are illustrated in Table 2. Some of these problems are carryovers, while some have emerged as a result or as part of the fiscal crises described earlier.

Table 2.Major Problems in Government Financial Management
Public Expenditure Planning
Absence of expenditure priorities
Lack of link with macroeconomic framework
Inadequate review of programs
Absence of budgetary guidance to spending agencies
Poor preparatory work in spending agencies
Absence of contingency plans
Inadequate attention to operation and maintenance, expenditures, public debt budgeting, and government lending programs
Inadequate guidance on price factors
Separation of personnel determination from annual budget determination
Lack of attention to volume and productivity factors
Resource Planning
Absence of detailed estimates of revenues and receipts over the medium term
Lack of convergence between resource and expenditure budgets during budget formulation
Budget Structures
Inconsistent practices in classifying current and capital items
Program and object categories inconsistent with National Income Account classification
Classification practices unsuited to management requirements
Excessive number of extrabudgetary accounts
Inadequate links between development plan and annual budget
Budget Implementation
Rigidity in release of funds
Excessive reliance on central controls
Inadequate financial management capability in spending agencies
Lack of efficiency indicators
Absence of cost data
Poor cash management
Government Accounting and Financial Reporting
Absence of commitment accounting
Extended lags in consolidation of accounts
Difficulty in reconciling with monetary accounts
Outdated payroll systems
Lack of differentiated focus in fiscal reporting for policy purposes
Long delays in submission of periodic reports

Allocation of Expenditures

The viability of any budget depends on the information available on competing demands, costs of projects and programs, and macroeconomic linkages and implications. Although political decisions may finally be made that are contrary to economic and financial indicators, the budgetary process should be organized to generate the data needed. Recent experience has shown that governments have to some extent answered the allocation issues between public and private sectors, but have yet to achieve a balance among and within programs. This allocative balance appears to have been further skewed in the context of crisis budgeting as a result of arbitrary limits imposed on budgetary inputs.

The process is also not generating data on the future implications of current policies, or on the operations and expenditures needed to maintain completed projects. Decisions are therefore piecemeal, some as part of the formal budget and some outside the process and the budget. Also, the revenue and expenditure budgets lack congruence, which frequently contributes to situations in which outlays are determined without reference to resources available. As a result, there has been a shift from the strategic management of the budget to tactical approaches that imply changes in policy posture.

Uncertainty

As a result of economic uncertainty and the lack of ability of systems to reckon with it, budgets considered to be policy instruments and embodiments of programs of action were submitted much too late in the fiscal year. Instead of promoting a coherent strategy, they were put together in a hurry and more as a ritual, with more prayer than reason. Also, budgets submitted so late engendered uncertainty within the spending departments and in the economy at large. Sometimes, no budgets were submitted, and the previous year’s budget became, by default, the budget for the current year.

Budget Structure

Budget structures, which were often reorganized to conform to program budgeting tenets and to promote a management bias in government, became outmoded, owing to the lack of a periodic update and to the rapid changes in government policies and activities.

Budget Implementation

Budget implementation suffered heavily, as did budget preparation and submission. Frequently, midstream changes in allocations exacerbated the uncertainty and contributed to a rush of expenditures and to excess expenditures in several areas. Indeed, the atmosphere encouraged the perverse idea that spending agencies were better off using their allocations regardless of the results, because they constituted legitimate claims for further allocations in subsequent years.

Accounting System

Accounting systems remained largely unresponsive to efforts to improve them. Little or no discernible progress was made in the measurement of costs. Fiscal reporting continued to be incomplete, lacking in purpose, and frequently delayed. Moreover, above- and below-the-line items of a budget were not reconciled. Instead of facilitating forecasting of cash requirements and debt management coordination, cash management became a negative process intended primarily to curtail payments. Even the conventional wisdom that accounting facilitates legislative accountability became debatable, as the accounting systems that continued to employ large numbers of people provided neither comprehensive nor timely data.

Financial Management

Financial management was dominated by central controls that were excessively process oriented. Effective communication between the central and the spending agencies about resource realities was lacking. Centralization, while contributing to an avoidable abuse of power and to trivializing controls, imposed an additional strain on the process and on policymakers. More important, it contributed to a loss of financial consciousness in the spending agencies. As the types and instruments of control increased, efforts to control waste and abuse of authority became diffuse and lacked accountability. Procedures and rules were frequently perverse and overwhelmed substance. Control became more important than achievement, resulting in managers’ losing their sense of relevance and control.

While the preceding discussion underlines the pervasiveness of the problems and the need for improvement, the issue of why these problems accumulated, despite a continuing effort to improve government financial management systems, remains. The answers vary among countries, depending on the specific factors in each case. Some common factors, however, can be identified. To a large extent, the major contributing factor was the absence of a strategy for reform that took into account the requirements of a system. Too often, each reform introduced in industrial countries was replicated without the unique features of the local system being taken into account. As the link between innovation and expected outcome was quite unclear, disillusionment quickly set in, the traditional organizational inertia contributed to a widespread sense of defeatism, and instead of determination and perseverance, a sense of despair prevailed. It was easier to seek alibis than to evaluate the causes. The situational factors also somewhat impeded the progress that could otherwise have been made. The changing economic context, particularly the magnitude of fiscal deficits, undoubtedly had an adverse impact. Time and again the extended lag between the recognition of a problem and the formulation of a strategy was demonstrated. In short, even when efforts to improve the system were made, they were too few and too late.

PROGNOSIS

Such a situation elicits two responses: a continuation of the current approaches or a firm determination to resolve it. The economic imperatives are such that the former would have little support. Indeed, the experience of the last five years shows greater ingenuity, not in terms of designing new systems but in terms of packaging the different elements into a practical strategy. Developing countries have little option but to take into account the severity of the problems described above, consolidate their few gains, and formulate strategies that reflect local needs and capabilities. In formulating these strategies two major premises must be recognized: (a) large organizations take time to reorient themselves to new systems and techniques; and (b) large organizations can perform only a few tasks at a time. Within these parameters, developing countries have to make choices about the systems available, the relevance of these systems to their situations, and implementation strategies. Their efforts need assistance from international organizations. The role of national organizations and the priorities for improvements are discussed below.

RECENT IMPROVEMENTS AND THEIR RELEVANCE FOR DEVELOPING COUNTRIES

Whereas the 1950s and the 1960s witnessed major innovations in financial management in terms of new systems to measure performance and to improve allocative mechanisms, recent improvements have been selective and have consisted of extending or refining the application of previous concepts. Table 3 summarizes these improvements. In applying them to developing countries, three major elements and a vital but supporting element need to be stressed.

Table 3.Recent Improvements in Government Financial Management
Broad AreaSystems and Techniques
Policy planning(a) Explicit recognition of resource realities
  • (1) Envelope or portfolio budgeting

  • (2) External legislative or constitutional limits

(b) Resource planning and utilization
  • (1) Global targets or ceilings on revenues, outlays, and deficits

  • (2) Improved planning of impact of cuts in expenditure

  • (3) Contingency planning

Budget systems(a) Multiyear expenditure planning

(b) Formulation of “core” and “noncore” budgets

(c) Scrutinies and reviews

(d) Improved budget guidance

(e) Efficiency controls
Organization improvements(a) Improved balance between central and spending agencies through delegation of enhanced powers and responsibilities

(b) Improved fiscal reporting
Budget implementation(a) Cash management system

(b) Cost measurement

(c) Improved evaluation

The improvements should aim at (1) forging stronger links between the strategic planning system, the budgeting and cash planning, and the control systems; (2) strengthening links between inputs and outputs; and (3) reconciling the interests of aggregate policy management and the disaggregated interests of managers.

The senior managements of both the central and the spending agencies should commit themselves to implementing the improvements. This implementation will involve reforming the institutional, systemic, and technical aspects of financial management.

In the institutional area, immediate efforts are needed to improve the balance between the central and the spending agencies. Although several factors emphasize the general need for improved balance, three are particularly urgent. First, excessive centralization during periods of economic crisis has had the unintended effect of reducing financial consciousness in spending agencies and encouraging needless dependence on central agencies. Governments have grown so large that central commands have neither a uniform nor a desired effect. The realities of modern organization are such that more powers and tasks need to be decentralized if policy and financial considerations are to be integrated. Second, the emphasis from the community’s point of view is going to be on the delivery of timely, courteous, and efficient services, which in turn underlines the need for greater decentralization. Third, the spending agencies have to be made accountable for results, and appropriate devices such as the contract programs recently adapted in public enterprises need to be devised for them. Agencies can only be expected to manage their affairs if they are permitted to be managers.

In the systemic area, greater emphasis is needed on policy planning that would facilitate a more precise identification of the financial implications of current policies and their macroeconomic linkages. Although some countries have introduced multiyear expenditure planning, they have not become fully operational, and technical improvements are often indicated. In particular, it is necessary to ensure a periodic convergence between resource and expenditure budgets and to introduce planning reserves to meet unforeseen contingencies. Similarly, more effort is indicated in measuring costs and in preparing profiles of running costs for current programs. These efforts have to be accompanied by improvements in applying evaluation techniques. Together, these improvements will strengthen the budgetary process.

In the technical area, it is of the utmost importance that accounting systems are reviewed and made more functional in their orientation. Even the introduction of electronic data processing technology has yielded only moderate results, as the systemic deficiencies have remained unaddressed. The systems should be re-evaluated now to provide timely data. Similarly, the coverage of the budget should be reviewed to find out whether the creation of numerous extrabudgetary funds has effectively reduced its function as a policy instrument. As an integral part of this effort, tax expenditures need to be identified and budgetary presentation improved to achieve greater transparency of government transactions.

Another area that continues to be of vital importance is the development of human resources. No institutional and systemic development can be sustained without adequate support from the human element. As emphasis in financial management shifts from accounting of moneys spent or raised to accountability for results and for delivery of results, more tasks will devolve on the personnel concerned. In the past, the lack of properly trained staff, despite several notable training programs to enhance technical skills, was a major handicap. To perform new tasks with improved productivity in the public sector requires that more efforts be devoted to human resource development.

ROLE OF NATIONAL AUTHORITIES

Improvement of institutions, as past experience conclusively demonstrates, is a long-term process more suited to long-distance runners than sprinters. A fourfold approach would be appropriate: (1) an effort should be initiated to review the problems of the institutions and to identify the core problems to be attacked; (2) once these problems are identified, governments should formulate strategies to solve them, which should take into account the priorities as well as the local institutional realities; (3) greater effort should be devoted to the phasing of the implementation of the strategy after taking into account the human and financial aspects as well as the linkages among different elements of the strategy; and (4) the authorities should identify those areas that can be undertaken from their own resources and those that require external aid.

Considerable literature on the subject exists, replete with country studies and horizontal surveys.

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