I Overview

Jack Diamond
Published Date:
April 2006
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Among the major challenges faced by transitional and emerging market economies is the need to adjust institutions to function in an increasingly market-oriented and global environment. Among the reforms that middle-income countries have looked to emulate are the budget reforms that have been introduced in OECD member countries since the 1980s. These reforms have reoriented budgeting from the traditional focus on inputs to a new focus on the results derived from these inputs. This latter focus has often been termed performance or results-based budgeting. However, the resulting budget systems embody more than a change in the process of budgeting. They reflect a fundamental change in budget management, away from traditional, centralized control systems to more decentralized management models.

It is argued in Section II that this reform process can be characterized as following three fundamental tracks: first, to allow managers greater flexibility in managing resources; second, to give them greater certainty in resourcing; and third, to introduce a system of rewards and penalties to pressure them to perform, in the sense of achieving the stated objectives of government policy. The pursuit of this three-track reform process in turn has fundamentally altered the accountability relationships within government by replacing detailed central controls with greater flexibility for budget managers operating at “arm’s length.” These new accountability relationships are designed to impose discipline on this new performance management framework, are oriented toward results rather than toward inputs, and can be viewed as the cornerstone of the new performance management model. Not surprisingly, their introduction has generally required considerable effort to restructure the budget system.

Usually, the first step is to improve the definition of government programs and clarify their objectives, to ensure that programs are prioritized according to a strategic policy framework. While the need for a meaningful link between policy and budgeting has long been recognized, it has also consistently proved elusive, as indicated by a brief review of the history of the performance budgeting approach. Officials in most emerging economies accept that the central role of the program structure is to translate broad policies into activities and projects that can be costed, with the identified resource requirements approved as budget appropriations. At the same time, many also appreciate that this cannot be viewed as a one-time annual exercise. Increasing numbers of countries are adopting medium-term budget frameworks (MTBFs) to assist in capturing the full costs of activities and projects over time, and hence to better plan programs, to improve prioritization among them, and to provide some overall discipline over their resource use. However, as discussed in Section III, developing and maintaining an MTBF is not always easy.

The next step in creating the new accountability framework is to link inputs with program outcomes, and then to make performance information relevant to managers by tying this information to resource allocation decisions. As discussed in Section IV, the definition and measurement of program outputs (and, even more so, of program outcomes) is often problematic. Also, there are added requirements, namely to produce such performance information on a consistent basis, to provide incentives for managers to use this information, and to monitor the managers’ performance against these standards. Not surprisingly, it is likely to prove difficult and costly for many emerging economies to implement a full-blown performance management system such as that found, for example, in New Zealand or Australia.

The remainder of this study discusses the type of changes required to facilitate adoption of the new budget management model. Based on OECD country experiences, it argues that, first, certain basic safeguards should be put in place to ensure that public expenditure management (PEM) systems are able to accommodate the new demands. Second, the new accountability framework generally requires complementary changes in the way government operations are institutionally organized. This in turn often requires parallel changes in the legal framework. Third, a considerable investment must be made, both politically and financially, to manage the reform process.

Three aspects of the PEM system that often are weak in emerging countries and require upgrading are discussed in Section V. First, there is the need to strengthen internal controls. Before attempting to give agencies wider responsibilities in resource allocation, it is essential to ensure that they are operating within an effective financial management framework. Good internal control is an important feature of this framework. Without satisfactory controls, management may not detect serious errors and irregularities, and the work of the central oversight agencies, as well as external audit, becomes more difficult. Second, internal audit is a central component of internal financial controls aimed at protecting the government’s financial interests. Third, there is typically a greater need to apply information technology. Against the background of the ever-growing volume and complexity of government financial operations, timely management information reports in a usable form are clearly of critical importance to fiscal managers. Tailoring such reports to management needs through a computerized financial information system has been a general PEM reform undertaken in various parts of the world. This has not been easy, and the new performance information requirements are likely to make this more difficult. Fourth, preparing this new performance information requires that institutions have the capacity to capture the full cost of programs and activities so that these can be related to performance measures to judge program performance. Unfortunately, such cost accounting expertise is often scarce in government.

Section VI reviews in greater depth one of the most discussed tools for strengthening government performance—upgrading the government accounting system from a cash to an accrual basis. The typical government accounting system, even if conceptually well defined and internally consistent, is a cash-based system or, at most, a modified cash system. The emphasis is on matching approved items of spending with actual cash outlays, the last stage of spending. This may be adequate for the compliance and stabilization objectives of the ministry of finance (MoF) but it is less relevant for budget managers in government departments. It has been argued, therefore, that the move to the next stage of budget system development requires a switch in government accounting toward an accrual-based system. Those countries that have attempted to shift to accrual accounting have found it difficult and costly. An argument can be made that many of the benefits of improved costing derived from accrual accounting can be obtained by other means, and accordingly, that perhaps an intermediary move to accruals is all that should be attempted by emerging economies.

The performance budget management approach requires introducing enhanced accountability with improved transparency, further emphasizing the evaluation of outputs in relation to inputs, and streamlining control mechanisms to balance control needs and new efficiency requirements arising from more decentralized budget management. Moving to this management model has created parallel pressures to reorganize the way that governments do business. This aspect of budget reforms is taken up in Section VII. To provide a framework for discussing the wide range of institutional innovations, these are ordered into five main groups, each characterized as a progressive shift away from the traditional, centralized budget management model. These groups are characterized as the five Ds—deconcentration, decentralization, delegation, devolution, and divestment. The latter three are most closely associated with the new performance management approach.

Two aspects of these new arrangements that have received the most attention internationally are high-lighted—the role of contracting in government and the role of more autonomous devolved management units, the so-called agency model. The study warns that these approaches can be problematic, especially initially if administrative and accountability systems are not sufficiently robust. Full output and performance contracting is very resource-demanding and has been fully realized in only a few fairly advanced countries. Not surprisingly, even more limited movement in this direction is likely to strain the administrative systems in emerging economies. Similarly, the demands on PEM systems are quite heavy, especially with regard to reporting requirements and the skills required of managers. Similar concerns are expressed with regard to various strategies for divesting or sharing government responsibility for providing public services, through such mechanisms as contracting and private-public partnerships (PPPs).

The fact that it is difficult to find emerging economies that have made rapid progress on all three tracks of the reform process indicates that there are important implementation problems. Section VIII suggests that many of these difficulties have arisen from the lack of basic management infrastructure within the budget system. The capacity to successfully link policies with programs through strategic planning mechanisms requires the skills to construct MTBFs with well-defined programs. It requires analytical skills and adequate reporting systems to make clear the relationship between the resources used by a program and its outputs and/or policy results (outcomes). As indicated, the basic work of program design and program costing is unlikely to be straightforward and is likely to demand skills, such as cost accounting, which are often in short supply. At the same time, this new approach to budget management also requires parallel administrative procedures to activate the strategic plans and the program structure for decision making. This move inevitably must reflect the reform capacity of the country and, to be successful, should not be implemented too rapidly and should be carefully sequenced. As argued in Section VIII, the transformation from traditional budgeting procedures is likely to require a substantial effort to manage the change process, a dimension which has often been overlooked. Thus, for many countries, human resource constraints may impede, or at least slow, the move to performance budgeting.

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