This section examines the implementation of budget system reform, using the experience of countries that have attempted such reform to identify the principal elements of a successful change-management strategy and to highlight some of the lessons to be learned. Particular attention is paid to overcoming the constraint of limited managerial capacity, which can limit a country’s ability both to operate the new budget system and to engineer the move from one budget system to another.
What Can Be Learned from the OECD Experience?
It is perhaps not surprising that the fundamental changes in budget management that have been introduced in the more institutionally advanced member countries of the OECD have caught the attention of many middle-income and emerging market countries, which now seek to adopt similar reforms. As a consequence, the Fiscal Affairs Department of the International Monetary Fund has increasingly faced demands for technical assistance arising from these sources. The department’s experience has revealed that, although it is not too difficult to design budget reform measures, nor to specify detailed implementation plans, the lack of management skills is often an important constraint. This constraint has two dimensions. The first is the substantial management capacity required to operate the new type of budget management model. The second, and arguably more important, is the change-management skills required to introduce new systems, to sustain reform efforts, to follow through on implementation, and to adapt to contingencies and changes in the external environment. There are several important lessons for middle-income countries that look to emulate the OECD budget reforms.
Budget Reform Is an Evolutionary and Not a Discrete Process
Budget reform is an evolving process, with budget systems moving through distinct stages. A modern budget system should be able to meet three main requirements: first, to ensure control over expenditures so that they are consistent with the budget law; second, to stabilize the economy by timely and efficient adjustment mechanisms for the fiscal aggregates; and third, to promote allocative and technical efficiency in service delivery through procedures that provide incentives for greater productivity. It is possible to characterize the evolution of budget systems as a gradual movement through distinct stages defined by progressively assuming, and placing different emphasis on, these three requirements.
There Is a General Recognition of the Need for Budget System Reform
Middle-income countries typically find themselves facing common problems arising from the heritage of traditional budget management systems. Specifically, past attempts to ensure that budgetary processes would deliver a satisfactory aggregate fiscal outcome in support of macroeconomic stabilization have often involved imposing a number of limitations on budget managers. Even when care was taken to incorporate some degree of budget flexibility, typically the budget systems have been left with a complex set of restrictions. These are increasingly recognized as diminishing the allocative and operational efficiency of budget execution, normally by leaving budget managers to operate with only limited responsibility for results. Accordingly, there is growing acceptance that the next stage of reform is to provide greater inducement for managers to focus on possible improvements in allocative and operational efficiency at the program delivery level. However, before this can be done, there must be a strong enough consensus—a critical mass of impetus for reform—to enable a shift in the budget management model. In the OECD countries, this consensus was reached from two separate directions: the increasingly obvious limitations of traditional compliance-oriented budget systems, and increased realization that stabilization and efficiency objectives were not necessarily in competition.
The Budget Reform Strategy Is a Major Part of the Government’s Overall Policy
Once the need for reform is recognized and accepted, a common approach is to make it part of the government’s fiscal strategy and a central element of government policy. The reform initiative is “owned” and supported by all ministries, not just the MoF or the budget office. In this way, it forms a critical element of management strategy for all budget institutions. All public sector managers assume responsibility for its implementation, rather than leaving it to those managing the agencies’ budgets or accounting systems. This high-level commitment facilitates the required changes in administrative procedures and makes central agencies more willing to devolve budget management.
There Must Be Adequate Levels of Fiscal Control
Before advancing down the road of a more flexible, more decentralized budget management model, all countries must establish adequate levels of control to ensure compliance and stabilization objectives. The three prongs of reform—providing flexibility to budget managers, achieving greater certainty about budget funding, and increasing pressure to perform—need to be pursued in parallel to ensure the overall success of the reform process. Allowing budget managers greater freedom without putting in place an accountability structure to ensure improvements in performance, as described in Section IV, could increase rather than decrease budget inefficiencies. At the same time, providing a greater degree of resource certainty may involve a trade-off against the need to cut spending for stabilization purposes. It is, therefore, essential to proceed down these three tracks in a highly coordinated manner.
There Is a Need to “Engineer” Budget Reforms
Reforms must be engineered—a reform plan formulated, an implementation strategy agreed, and implementation of the reform program managed to achieve the objectives and sustain the reform initiative. The reform program has to be “sold” to the main stakeholders in the budget system. Perhaps more important, a reform team must be identified and empowered to carry out the reform. It is this aspect of the reform process—the exercise in change management—that is central to this section. Change management addresses the question of how to engineer the shift from one budget management model to the other—literally, introducing a shift within government from a compliance to a performance culture.
The Overall Approach to Reform
As suggested in previous sections, in many emerging economies, reservations about the budget reform process relate less to the specific changes proposed and more to concerns about how the reform will be implemented. It is possible to identify the sources of some of these concerns.
A Big Bang or an Incremental Approach?
A conservative approach is recommended for pursuing changes to budget procedures that will improve the trade-off between the objectives of stabilization and efficiency in resource use. Specifically, the reform strategy should be based on relatively small, sequential changes rather than on concentrated reforms that are part of a single, high-profile package. This is recommended for two main reasons:
The incremental approach to reform addresses the “chicken or egg” problem of building financial management skills within spending agencies. Highly centralized budgeting discourages the development of financial and allocative skills in agencies. An evolutionary approach to budget reform allows agencies to expand their financial management skills as greater management responsibilities devolve to them. This reduces the risk, which may arise under a more radical approach to reform, that a control vacuum will emerge because spending agencies are unready to abruptly take over responsibility for allocative decisions previously determined at the central level.
The incremental approach minimizes other risks involved in reform. The pace at which additional responsibility is devolved can be matched against the pace at which capacity builds in agencies. The incremental approach, therefore, minimizes the risk that increased flexibility to spending agencies might contribute to budget overruns should revenue conditions deteriorate.
Unfortunately, a cautious, step-by-step approach to reform may make the process appear to lack coherence. When pursued separately, important legal and institutional initiatives, programs, and projects may not appear to fit together into an overall, coordinated reform plan. The incremental approach makes it difficult to specify a clear timetable for the reform process and to place emphasis on the sequencing of the individual components of the reform. This raises questions about the role of the agents of change—and most specifically, the central budget office.
Top-Down or Bottom-Up Reform?
The OECD-type budget reforms require a different budget management model. The central budget office must take measures to enhance performance within budget institutions, which is rather different from its traditional role. In traditional budget systems, the function of the central budget office is to act more as a policeman, ensuring compliance with the budget, monitoring budget progress, and intervening when things go off track. The new budget management model requires a fundamental institutional shift in public expenditure management, first, by reorienting the central budget office’s role, and second, by devolving fiscal management decision making. This in turn implies a sustained effort for training and adequate time to develop a new culture, as indicated by Malaysia’s experience in introducing its Modified Budget System, one of the more successful reform efforts (Box 46).
Not only does the central budget office have to increase the capacity of government agencies to assume an enhanced management function, but, at the same time, it has to change its own work practices and realign its objectives. It must still ensure that the resource allocations are consistent with overall fiscal targets and the government’s program objectives. However, rather than dictating how these are to be attained, as in the old system, the budget office must now establish guidelines and procedures for reviewing policy changes, maintaining baselines and databases for measuring the budgetary impact of changes, and conducting an ongoing evaluation of programs and measurement of performance.148 Moreover, the budget office is expected to provide central guidance to the reform process, producing handbooks and advising on best management practices. In attempting to do so, it is likely to initially meet its own capacity constraints.
The problems are compounded by the fact that the reformed budget management model is decidedly more decentralized. Attempting to install a bottom-up system from the top down may involve a fundamental contradiction: the greater the success in decentralizing decision making, the weaker the central budget office’s leverage over agencies. With decentralization, and the resultant managerial freedom, the center loses effective control over the budget, which will most likely work against efficiency in resource allocation. The budget office must adapt its work practices and build the information systems required for this new environment—and may, of course, encounter internal resistance to undertaking such fundamental changes.
Therefore, in terms of engineering these reforms, there may be conflicts inherent in a top-down approach that directs managerial improvement from the center. For example, although it may be necessary, it may not be appropriate for the central budget office to lead the way and to increase its capacity to assist others in implementing the reforms. If it tries to do this too aggressively, it may risk smothering managerial initiative and encouraging the old compliance mentality. It is also unclear whether a greater devolution of decision making is in the central budget office’s interest, both in the narrow view of attaining its compliance and stabilization objectives, or more generally, in reducing its overall influence over the budget process. There are costs as well as benefits to moving away from traditional budgeting methods, and the principal agents of change may not necessarily see a net gain to themselves in advancing this process. For all these reasons, it is important to buttress budget system reforms with wider governance reforms—as indeed has been the case with pioneering OECD countries—stressing transparency and reinforcing the legal framework of budget management.
Elements of a Reform Strategy
The fact that OECD countries made this change in an evolutionary rather than a discrete manner and that their reform efforts are continuing brings out the importance of the change process. The implementation strategy and the mechanics of implementation should be focused on managing the reform process as a whole, rather than concentrating on individual reform elements.149
Change-management methodology emphasizes the need to address crucial components for successful institutional change that should be followed in a logical sequence (Kotter, 1996). One of the most widely known prescriptions for successful change management is shown in Box 47. Although this literature is derived from the private sector and the experiences of transforming large corporations, there are obvious parallels with attempts to reform a government’s budget management system.
The experience of government modernization programs in emerging market countries indicates that the first two steps in Box 47, getting agreement from top decision makers that the budget system needs to be made more flexible, may not be such a problem. That is, there already exist a sense of urgency and peer group pressure for reform. Similarly, creating a common vision about the organizational and procedural changes required is not so difficult: the vision is to adopt OECD budget systems. However, the real constraint is the human element in implementing such institutional change (steps four through seven). Generally, not enough attention is paid to the agents of change—identifying them, offering them incentives to undertake reforms, and removing the constraints they face in sustaining these reforms. Accordingly, successful budget system reform requires engineering these three steps:
The Malaysian Modified Budget System
The existing planning, programming, and budgeting system (PPBS) system, modeled on the U.S. system, was replaced by the Modified Budgeting System (MBS) in 1990 to place greater emphasis on outputs and outcomes. The MBS was piloted first in three agencies and, based on the lessons learned, it was phased in over a period of five years for the operating budget only. This was slightly modified in 2001, when a two-year budgeting system was adopted, along with an important annual review of policies.
Key Elements of the Reform
Based on a longer-term strategic plan: Policies are geared to Vision 2020, which envisions Malaysia as a fully developed country by that year. Policies are categorized as either existing policies, new policies, or nonrecurring (“one-off”) policies. Operational plans of agencies differentiate short-term from longer-term strategies to achieve desired policy objectives. For the budget, these are reviewed centrally to determine whether they will realistically meet policy objectives, and after five years there is a more fundamental review of the programs.
Improved financial compliance: Macro and agency fiscal discipline are strengthened throughout the system, with improved financial planning and control systems that use information technology. This is supported by several other reforms: strengthened policy development and coordination, organizational restructuring, and improved management of human resources.
Enhanced quality of management: MoF from the start tightened financial discipline internally. In return, managers were given more autonomy, with flexibility to move funds between programs and activities. They were also given more stability in their resource base, especially after adoption of the two-year budget framework. All budgetary requests are linked directly with policy, and each ministry is given an expenditure target for existing policies. New policies can be created as a consequence of expanding existing policy, and the agency can request extra funding for a new policy or a one-off policy.
Improved efficiency of government operations: To determine impact, agencies are required to draw up performance indicators and a Program Agreement to indicate how the use of resources will result in outputs and impacts, as indicated by the agreed performance measures. The Program Agreement emphasizes identifying the agencies’ clients.
There were delays, even with reform efforts carefully planned, managed, and phased in over time.
This effort was centrally managed, with two divisions in the MoF in charge of training and implementation. Their coordination, at least initially, posed problems.
It took time to convince the civil service that the MBS was workable and to overcome the difficulties of categorizing outputs/impacts and developing costing systems.
Training was a large component of the reform effort, but the scale of this effort meant it was difficult for all second-and third-tier organizations to fully implement the MBS.
It took time to get managers to manage. This change in culture within agencies was difficult to engineer, and there was a lingering preference to let the MoF make decisions as in the past.
The Steps for Creating Major Institutional Change
Recognize a sense of urgency to make a change.
Develop a powerful enough coalition to support the change.
Identify a champion of change who creates and communicates a common vision.
Empower and give resources to others to implement this vision.
Plan for early successes (“easy wins”) for positive demonstration effects.
Build on these early successes to sustain the momentum for reform.
Institutionalize the changes so that they become a part of the organization’s culture.
Identify agents of change. Who are the champions of reform? Who is going to recognize the need for reform, design the reform, and monitor and implement the reform?
Assess and ensure the adequacy of the means at their disposal. By what processes and with what means will reform be carried out? What is the capacity to carry forward reform—is this capacity adequate or does it require administrative restructuring, changes in procedures, or new skills?
Restructure the incentives to undertake and sustain reform. In what ways will reforms benefit the individual rather than the system as a whole? Will individuals be compensated for the costs of the effort involved? Once reform incentives are established, how are they to be maintained and protected?
The remainder of this section proposes some answers to these questions.
The Agents of Change
In a traditional, highly centralized budget system, there is a presumption that changes are derived top down, from the MoF and, specifically, from the budget office. This is not necessarily the case under a devolved budget management model. At least initially, any relaxation of centralized controls may meet some resistance from the central budget office, which instead should be the key agent of change. This resistance can arise from a number of sources.
First, there is the fear of the unknown. Why adopt different approaches when the present ones have not broken down and appear to be delivering at least the bottom-line fiscal result? The budget office may not be convinced of the need for a new budget management model which moves away from compliance and stabilization objectives and begins to emphasize efficiency and effectiveness in resource use. Obviously, budget officers will be more easily convinced if they already have in place a management framework that ensures basic compliance with the law and allows sufficient certainty in the fiscal outcome to minimize short-run disruptions to spending plans that may arise from the need to ensure fiscal stability.
Second, this conservatism is often reinforced by a concern that relaxing central controls and giving budget program managers greater personal freedom will result in more waste and corruption. This concern arises because waste is often invisible in traditional budget systems, which focus more on the correct use of inputs but not on the possible waste embodied in the resulting outputs. Under traditional systems, control is over total inputs and not their composition, and this leads to a concern that, with the limitations of existing information systems, allowing freedom in the composition of inputs will subvert this macro control. It is also important to recognize that, under any system, where line agency accounting and internal controls are rudimentary and poor, corruption may increase. It follows that there should be a major program to upgrade agencies’ financial management skills to some basic level to offer the budget office assurances about their fiscal responsibility.150
Third, there is often a natural reluctance to give up the power that goes with centralized control. Change is not only threatening, but it may also mean a loss of pecuniary or other benefits that derive from the authority to release detailed line items to spending agencies. As a consequence, the central budget office, which should be the leader of reform, may become its chief impediment. The question becomes how best to restructure incentives to move the MoF’s budget office toward a new role. The answer is to use consistent pressure from across the government and to continue to redefine the MoF’s new role in the context of a reform of the whole budget system.
Fourth, the MoF generally has limited capacity for change management. In private sector companies, change management receives much top-level attention and tends to be heavily funded. In the public sector, it typically suffers from benign neglect. Often there is a need to inject new capacity or to build up existing capacity for change within government. Indeed, with such considerations in mind, the leaders of reform to a decentralized budget management model may be more likely to be found in the line agencies or lower levels of government than in the MoF.
Moreover, the management constraint does not merely hinder the successful implementation of the reform process. The new budget model being introduced implies that public officials will cease being administrators and will assume a management role akin to that in the private sector.151 Unfortunately, a centralized, compliance-oriented budget management system does not foster the creation of such management capacity in either the MoF or the line agencies. These officials typically have spent most of their working lives in a compliance-oriented environment with a “command and control” management culture. Their reflex responses typically are to manipulate detailed external control systems to protect their programs from the cash-rationing operations of the MoF. Line agency officials often see their role as administrators, consisting primarily of distributing limited cash to keep basic services functioning. This role does not recognize the value of good agency financial management, nor foster the acceptance of increased managerial responsibility.
How best to build management capacity in a compliance-oriented traditional budget system? There is no easy answer to this question. However, experience suggests that a “big bang” approach is difficult. An interesting case is Bolivia, where in 1988 the government developed a program to recruit a limited number of middle-level managers and to place them in a few key posts in each agency in order to enhance performance. A total of 653 key posts were originally planned but, by June 1993, only 69 had been filled. The strategy of sprinkling a small amount of managerial talent across a large number of agencies evidently had little impact, and a new approach was tried. From 1992, the government adopted a more successful, broader civil service reform with a longer time frame, with about 2,500 targeted posts to be incorporated into a newly formed Civil Service Program. The new strategy was to achieve a critical managerial mass within selected central administration agencies and to progressively expand the number of agencies in the program.
The experience of Bolivia, as well as of other middle-income countries, suggests that the solution to the management constraint involves tackling two main problems. First, building this capacity will take time and must be done in stages. Second, this phased approach should be an integral part of the reform’s design. One strategy for minimizing the risk of misuse or abuse of managerial authority, while recognizing that agency capacity building takes time, is the adoption of resource agreements. The approach used in Thailand, summarized in Box 48 and discussed more fully below, makes agencies’ access to greater managerial autonomy conditional on improved financial management. These systems, and the managerial capacity to operate them, if functioning properly, will be important assurances of the quality of data and the reliability of controls in the new devolved budget system.
The Means to Manage the Reform Process
The efforts of many middle-income countries and even more developing countries to improve budget systems have been stalled prematurely and overtaken by changing external events. This is a result in part of failures in the management of the change process and in part of a lack of adequate resources to carry out the reforms. There are some general lessons to be learned about change-management strategies, all subject to the qualification of exceptions.
Thailand: Line Agencies Reform Contract
Main elements of the approach:
Identify reform-oriented line agencies.
Offer them a contract or resource agreement.
Reduce external control by Bureau of the Budget, in exchange for demonstrated improvements in agency financial management.
The agency must demonstrate the achievement of “hurdle standards” in seven areas:
– Budget planning
– Output costing
– Procurement management
– Budget/funds control
– Financial and performance reporting
– Asset management
– Internal audit
Emphasize objectives. The cultural shift from a compliance-oriented to a performance-oriented budget management model essentially involves a shift from focusing on inputs and how they are employed to focusing on outputs and how they fulfill the original budget objectives. This is a move away from traditional administrative procedures and toward a more modern management orientation, focused on meeting clear objectives. Not surprisingly then, a key to making a successful transition from one budget management model to the other is to focus on objectives. Those involved in the pathbreaking public sector reform processes in New Zealand and Australia have stressed this aspect of reform.152
Keep participants focused on objectives. Publicizing the objectives is one way to create incentives and put pressure on participants to meet their objectives, as well as a way to hold them accountable for their results. The United Kingdom’s “Citizen’s Charter” publicly committed public entities to meet specific performance standards and identified the means of redress when they failed to do so. This approach has given way to the use of Public Sector Agreement targets to publicize agencies’ objectives and hold them accountable (see Box 20). In the United States, the National Performance Review during 1992–2000 placed heavy emphasis on measuring and publishing results.
Evaluate performance as a tool for enforcing performance. There must be feedback mechanisms to continuously improve the means by which agencies pursue their objectives. At the same time, these mechanisms must be cost-effective, avoid excessive transaction costs, and carry minimal risks that their application will produce biased, inaccurate, or inconclusive results.
Reward good performance and sanction poor performance. The reform leaders must ensure a clear link between performance and rewards. Establishing clear performance accountability involves, first, a threshold level of basic financial and personnel management systems that can be used to report on performance, and second, a performance-oriented incentive framework that links rewards to performance, as discussed in Section IV. Many middle-income countries are handicapped in following the above strategy, however, because traditional budget systems put little emphasis on performance, and managers in line agencies, therefore, are not used to subjecting new policy proposals to critical analysis. Nor are they accustomed to managing expenditures to achieve a particular outcome. There is a need, therefore, in many countries to develop such evaluation skills in agency management and also to establish information systems based on indicators of output and performance that support such activities.
Upgrade basic management tools to provide adequate, relevant, and timely information. Some elements of this are described in Section V, such as the need to strengthen internal controls and internal audit, to apply information technology in upgrading information systems, and to expand capacity for cost accounting. In particular, there is a critical need to upgrade the accounting system, as explained in Section VI.
A top-down reform process may rapidly produce diminishing returns. As noted, any attempt to install what is essentially a bottom-up system from the top down involves a fundamental contradiction in that success in decentralizing decision making will simultaneously weaken the budget office’s leverage over agencies. The budget office must therefore expeditiously adapt its work practices and build up the information systems required for this new environment—and must overcome any internal resistance to making such fundamental changes.153
Restructuring Incentives to Support Reform
The reform program cannot ignore the interests of stakeholders, particularly the key players such as the central budget office and the targeted agencies. If the budget office cannot see that the reform process will safeguard its basic controls over the budgetary process, it is unlikely to be a strong proponent of reform. If the systems being created under the reform process do not provide agency-specific management tools, it is unlikely that those systems will yield the desired results. There may also be a need to enlist the support of individual agency staff by involving them in the design and implementation, providing performance-linked institutional rewards, and introducing job transition assistance for retrenchment or retraining.
Some middle-income countries have used performance agreements between the central budget office and agencies to address some of these issues (Box 49). The process is managed centrally, typically by the budget office, and is described in a rather stylized fashion as a twofold approach of applying pressure from above and increasing capacity from below.
Applying Pressure from Above
The MoF encourages agencies to undertake in-depth evaluations of activities that might warrant a reconfiguration of resourcing to improve performance. These evaluations could be contracted out and could serve as an input to the preparation of an MTBF. The MoF might also institute an “efficiency dividend” policy, whereby agencies are required to find savings in their baseline budgets of an agreed percentage each year (Box 50). Over time, as improved accounting for assets allows, a capital charge could be introduced to ensure better asset management at the agency level.
Much of this effort is predicated on the MoF being able to obtain better information on agency performance. However, by itself, performance information provided to central agencies is a rather ineffective mechanism for ensuring that agencies actually use their new financial freedoms to enhance program outcomes rather than bureaucratic or personal goals. The center may set the new framework for budget management and put in place mechanisms to tighten control if agency management fails, but success ultimately depends on the capacity of agency management to adapt to new outside pressures. And this capacity comes from within an agency itself, rather than from the central level, through effective leadership of the agency, clear frameworks for operation and responsibility, effective management information systems, and proactive central coordinating divisions in the areas of agency accounting and budgeting. Hence the second approach:
Formal Performance Agreements between Central Authorities and Agencies in Latin America and the Caribbean1
Benefits derived by agencies:
Easier to hire key human resources
Enhanced managerial autonomy
Reliable cash flow relative to budget
Performance-linked institutional rewards
Technical assistance to improve management processes
Minimum reporting standards in financial and personnel management systems
A financial restructuring plan or institutional strengthening agreement with detailed implementation plan and deliverables
Agreed performance targets and associated reporting requirements
The Experiences of Australia and Sweden with Using an Efficiency Dividend
A number of countries, including Sweden and Australia, have introduced a charge against the baseline budget forecast for agencies. This charge, often called an efficiency or productivity dividend, aims to provide agencies with the incentive to continually seek new or more efficient means of undertaking ongoing government business. It also allows the government to redirect a portion of the efficiency gains to higher-priority activities. The charge should be small to allow managers room for maneuver. Even so, as the experiences of Australia and Sweden indicate, it is difficult to sustain these dividends politically for a prolonged period. Because it represents an across-the-board cut on inputs, it implies old-fashioned incrementalism (or in this case decrementalism) in budgeting and ideally should be used in conjunction with more performance-oriented efficiency improvements that focus more on outputs and outcomes, as was the case in Australia and Sweden.
The Australian efficiency dividend was introduced in 1987 on administrative budgets, applied to agencies’ total running costs. It was a uniform percentage cut applied each year and taken from portfolios before their budgets were released. It was applied irrespective of agency size or demonstrated efficiency. The rationale was to capture a proportion of productivity gains made by operational managers and return funds back to the government to be directed to priority areas. Initially, the rate was set at a flat 1.25 percent per annum in the 1987 budget, and in 1990 it was agreed to retain this rate for a further three years. Subsequently, a Parliamentary Committee Report recommended its retention but suggested that the government consider both reducing the rate and increasing the number of exemptions for small agencies. The rate was reduced to 1 percent as of July 1994 and by mid-1994, the number of exempted agencies had grown to 46. One reason the efficiency dividend could be relaxed was that from the late 1980s other efficiency and performance contracts were being used not only to promote efficiencies in input costs but also to promote improvements in levels of outputs. By the early 1990s, almost all agencies had various forms of resource agreements in place. It was found that, although savings were substantial, at least initially, total running costs did not decrease as new policies were approved; rather an element of “gaming” was introduced, with funds being recycled rather than saved. The nature of the federal budget was such that the dividend was only applied to administrative costs and many areas therefore escaped the discipline, including programs funded by the central government but administered by nonfederal agencies.
In Sweden, across-the-board cuts of the appropriations of all government agencies were introduced in the late 1970s as a means of taking into account productivity increases in the public sector. At that time, the increase in productivity in the private sector was estimated at 4 percent per annum and it was thought the government could do at least half as well. The 2 percent standard, or “the cheese-slicer” was introduced, subjecting all agencies to a 2 percent cut in their appropriations after allowance was made for cost increases in salaries and expenditure. Initially, some exemptions, full or partial, were allowed on grounds of proven efficiency or in cases where services would be reduced to unacceptable levels. It became politically unpopular, and many questioned its ability to spur efficiency, given that it was applied across-the-board and based on inputs with no regard to outputs. The rate became subject to political negotiation. Exemptions were made for agencies with particular problems and from the mid-1980s 2 percent could be replaced with savings of 5–6 percent dispersed over a three-year period. The standard was also subject to technical problems of interpretation. Before the cuts were applied, all agencies were compensated for salary increases and average inflation over the past two years so that they tended to be undercompensated in times of rising inflation and vice versa. Ex post changes were made after the cuts—agencies could be compensated for new assignments or have their appropriations further reduced for decreasing demand for services. Agencies could overdraw their appropriations for reasons considered “legitimate” by the government, e.g., to compensate for salary increases not previously taken into account. As a result, the cheese-slicer lacked transparency which was reinforced by a lack of interest in ex post evaluations. After 1990 it was shelved because of the economic crisis. Thereafter, more emphasis was placed on the central element of budget reform, cutting back through the review of programs—the “cake-slice approach”—designed to cut considerable pieces of the government sector programmatically.Sources: Wanna, Kelly, and Forster (2001); Brunsson (1995).
Increasing Capacity from Below
The central budget office, as the agency responsible for budget management, adopts a proactive role in the development of good management in the spending agencies to which it provides budget funding. This is a key element in the budget reform model based on devolution of financial freedoms and a more certain operating environment. This takes the budget office out of its traditional detailed control mode and toward a more managerial approach. Typically, some of the main elements in this approach are:
The budget office highlights and “sells” improved management in spending agencies as a precondition of the budget reform process.
The budget office develops competencies in the evaluation of internal resource allocation processes and structures in spending agencies, focusing particularly on the ability of a spending agency to identify cost-ineffective aspects of its activities and to reassign resources away from such areas.
The budget office develops a checklist of the attributes of management systems in spending agencies that are conducive to allocative flexibility.
The budget office then works with spending agencies in the application of these competencies to agency operations, with the ultimate goal that the agency will both undertake internal reallocation and identify savings options in response to external budget management requirements.
The budget office also initiates a review of performance indicators for each major department. This should begin with the enumeration of departmental activities and the objectives being pursued by each. Performance indicators already available in departments should then be matched to these objectives, and gaps in the existing range of performance indicators should be identified. Assistance should then be sought from sectoral experts to define and collect new performance indicators to fill these gaps, before the complete system of indicators is institutionalized.
Providing an Enabling Environment
Unlike a policy change, an institutional reform, like that involved in budget system reform, typically has no political constituency. No one in the general population is pressing for this reform, and even stakeholders may be difficult to mobilize because there may be a perception of powerlessness in bringing about enhanced expenditure benefits or improved efficiency in service delivery. One key to sustaining reforms revolves around how to generate the pressure for reform in society as a whole. From country experiences, what are the elements of such an enabling environment?
An Adequate Level of Fiscal Stability
Fiscal crisis can help highlight the need for reform, or it can deflect attention away from it. OECD countries carried out a major fiscal consolidation concurrently with introducing major fiscal reforms. The pressure for budget reform largely arose from rapid growth in the public sector in the 1970s and early 1980s, which raised questions as to whether this was affordable and whether it was providing value for money. The growth in public spending had been so sharp that there were doubts as to its sustainability, and there was a recognized need to find reductions in some sectors to satisfy emerging demands. There were general concerns that taxation levels were too high and that the public sector was crowding out the private sector, and these added to this pressure for change. The consequence was a substantial fiscal consolidation, which reduced budget deficits and stabilized debt levels, alongside the introduction of fundamental budget system reforms.154
In the OECD countries, then, fiscal crisis may have provided an opportunity to introduce fundamental reforms, making changes more easily accepted and more quickly implemented. However, in transition economies the experience has often been that, when the degree of fiscal stress was severe, the initial reaction of public officials was to muddle through, adopting short-term crisis management solutions that often were hostile to longer-term reform. Undoubtedly, the degree of crisis is important—too much can be disruptive and counterproductive to reform.155
Some qualifications are perhaps in order. First, perhaps more important than the degree of fiscal stress is the capacity of the budget system to adapt to it. If reliable mechanisms are in place, then fiscal stress is probably a secondary factor. Second, if fiscal stress is not so destabilizing as to allow some political and administrative stability, then its negative impact can be expected to be much diminished. In this scenario, there will be continuity in management to focus on solutions to the immediate problem and also to put in place more substantive changes to address the root of the problem.
Third, much depends on the reform strategy adopted. An approach that lacks focus and does not set clear priorities is most liable to fall prey to short-run crisis management. At the same time, an approach that is too ambitious and costly is also doomed. To be effective, performance-oriented public sector modernization involves immediate up-front costs and in all likelihood requires a substantial infusion of scarce managerial talent. Recognizing this, reform should be designed in a way that phases in the cost increases over a long enough period of time that the government can meet the increased fiscal costs, there is sufficient time to reap the benefits of improved efficiency, and the reform effort does not jeopardize the overall macro fiscal policy stance. A gradualist approach that covers agencies serially over a sustained period is also required by the fact that the professional human resources are in short supply; such an approach enables learning from mistakes. Moreover, the serial approach, by allowing reform to start with the most promising agencies, enhances the chances of demonstrating visible results early on, and thereby of providing momentum for reform.
Strengthened Overall Accountability
For reforms to be sustainable, it may be necessary to strengthen the overall accountability framework. Section IV emphasizes that the core of the new performance budgeting management model is a reformulated accountability system. The focus is accountability within the executive branch and the need for the accountability of budget managers to be clearly defined and changed. Whereas in the past they were held accountable for the correct use of inputs, now they are to be held accountable for the results of using those inputs. However, this is only one aspect of the overall accountability for the use of public funds. There is also a need for the executive to give an account to the legislature about how it is meeting its responsibilities as a whole, and this should be enforced by an independent external audit body that reports at least annually to the executive. Often these latter dimensions of accountability also need to be strengthened. The accountability of the executive often needs to be enhanced by prescribing fuller reporting ex ante and ex post of fiscal policy strategies and intentions, as well as of the financial and nonfinancial outcomes. The external audit office often needs to be better resourced, to be made more clearly independent from the executive, and to reorient its work to better serve the needs of the legislature. In the new performance budgeting model, this requires it to widen the scope of its audits beyond narrow financial compliance to give more emphasis to value-for-money audits. To strengthen accountability in these ways requires greater transparency within government.
Increased Emphasis on Fiscal Transparency
Transparency in government operations is increasingly regarded as an important precondition for good governance and sustainable economic growth—but, for the emerging economies, it is also an essential aspect of sustaining confidence in government and, through this, building support for the democratic system and economic advancement. The need for the latter has become particularly acute with the exposure of fiscal policies to international financial markets arising from increased market financing of deficits. Such exposure has required many governments to modify past policies and so has assisted in achieving fiscal discipline and improving resource allocation.156 Transparency is also an essential ingredient in establishing the new budget management model.
Promoting greater transparency is a means to bolster reform. Restructuring incentives by concentrating on the stakeholders within the budget system is unlikely to be enough—there is also the need for measures to activate clients in support of reform. Clients need to be empowered; quantitative performance indicators must be supplemented with indicators of quality; and client feedback must be strengthened and made more transparent.
One channel for accomplishing this is widely publicizing performance standards expected from particular public agencies and spelling out the specific steps the public can take to force agencies to meet these standards. The U.K. Citizen’s Charter attempted to do this at an aggregate level, but such initiatives are possible at a program level.
Supplementing Quantitative Performance Indicators with Indicators of Quality
The importance of performance indicators has long been recognized in reforms associated with performance budgeting, as evidenced by the ever-expanding literature on the subject. Also important is improving resource allocation for government by improving performance data and performance measurement. However, one can detect a new trend to obtain different types of performance data. Typically, performance data has been directed to two questions: how well services are delivered (efficiency), and whether planned objectives are being met (effectiveness). However, increasingly important is a third type of question: whether customers are satisfied with the results (quality). In the United States, the Government Performance and Results Act (GPRA) was enacted in August 1993 to improve the public’s confidence in government by holding agencies accountable for program results. Promoting a focus on results, improving the quality of services, and measuring customer/citizen satisfaction with government services were important elements of the act. The goal was to improve the delivery of services not only by requiring that managers establish plans for meeting their goals/objectives but also by providing feedback to managers regarding actual program results and quality (Box 51).157
Strengthening Consumer Feedback
Nowhere is this push to improve the efficiency and effectiveness of government service provision more noticeable than in the rapid adoption of IT in government, mirroring developments in the private sector. The spread of e-government has been increasingly documented.158 In the United States, there has been a rapid expansion in constituent relationship management technology (CRM, also known as customer relationship management)—a class of software designed to provide government agencies with the ability to manage their constituent relationships by providing stakeholders the means to contact their government via a variety of channels. Recorded contact information can be logged, analyzed, and then effectively employed in various business processes. The widespread use of e-government means that the analysis of consumer feedback data can be a powerful input to agency decision making. In this way, government performance can be monitored for the quality of different types of contacts, showing where the government is doing well and where improvements are required. Constituent data can be analyzed so that managers can segment their client groups in order to deliver more specifically tailored programs—and thereby improve the quality of service provision.
The U.S. Government Performance and Results Act, 1993
The Act is an amendment to the Budget and Accounting Act of 1921, covering all agencies of the federal government (only excluding legislative and judicial branches and the Central Intelligence Agency).
Important Elements of the Act
To improve citizen confidence in government by holding agencies accountable for program results.
To encourage reform through a series of pilot projects focused on setting goals, measuring performance, and reporting progress against goals.
To focus on results, improving the quality of services, and measuring customer/citizen satisfaction with government services.
To enhance decision making by disseminating information related to efficiency/effectiveness of federal programs.
Establish a system of interrelated plans and reports that are designed to provide the basis to link resources and results.
Each agency must produce a five-year strategic plan, which must be revised at least every three years.
Agencies have to develop annual performance plans, establishing specific program goals, identifying the resources required to meet those goals, and linking this with the strategic plan.
Agencies have to provide an annual performance report reviewing its success in achieving the previous year’s performance goals, and from this perspective explain any deviations.
Pilot projects are introduced to allow some agencies more flexibility and to waive certain administrative requirements for their annual performance plan, but managers are held accountable for achieving higher performance.
Introduction of a two-year pilot project of performance budgeting in a few agencies, providing Congress with information on the direct relationship between proposed program spending and expected program results.
Since its enactment, the GPRA has been continuously analyzed and reviewed by stakeholders and independent bodies. It has been found that some agencies have made substantial progress and others have found it difficult to meet its basic requirements. Major problems encountered were the ability to generate reliable data, problems in developing measures for programs/activities spanning more than one agency, and difficulty in making the transition to performance budgeting. Notwithstanding these difficulties, basic support for implementation of the GPRA continues.
The Need for a Compatible Legal and Regulatory Framework
A regulatory framework is required that establishes the broad parameters for ensuring adequate budgetary controls and granting appropriate managerial autonomy. The latter should be conditional on the agency management providing adequate accountability for those public resources under its stewardship.
At a minimum, this usually involves streamlining existing budget procedures and associated financial regulations. In centralized, compliance-oriented systems, there is usually a layered system of controls that has accumulated over the years. A set of controls is introduced to remedy some abuse. These controls are later circumvented, leading to the institution of additional controls to plug the gaps. The additional layers of controls further encourage managers to find ways to circumvent them to get things done, leading to a vicious cycle. There is a need to rid the system of these redundant and counterproductive controls.
However, many countries have gone further and have considered it necessary to set the new regulatory framework in a wider context of a framework fiscal law. In this they have often followed the model of New Zealand, a pioneer in budget reform. New Zealand laid down principles of responsible fiscal management as a framework for defining necessary fiscal procedures, fiscal targets, and fiscal reporting. As with New Zealand’s 1994 Fiscal Responsibility Act, most of the implementing legislation sought to enforce improved accountability and greater transparency in fiscal management, and in some cases to assuage governance concerns. Another potentially important aspect of adopting the new fiscal framework is its demonstration effect. In many countries there have been repeated efforts at budget system reform or major reform initiatives in the budget sphere. There is a natural tendency, therefore, for bureaucrats who have seen reforms come and go to be cynical and to adopt a “wait and see” strategy. Adopting a new, wide, sweeping regulatory framework thus has the added advantage of overcoming the bureaucracy’s “business as usual” attitude. The basic idea is to create rules and procedures that impose costs on governments and bureaucrats for deviating from fiscal responsibility.
While New Zealand provided a model for this legal framework, other OECD countries have also followed this path. The need for greater transparency in fiscal management was an overarching objective. Not only are governments required to specify and adopt agreed fiscal targets, but they are required to explain the policies underlying their attainment and, when deviating from this policy commitment, they are required to explain not only its rationale but also planned future corrective action. The Australian Charter of Budget Honesty and the United Kingdom’s Code for Fiscal Stability have adopted this approach, albeit in different forms. Notable among emerging economies, Brazil’s Fiscal Responsibility Law has been quite successful and influential. However, there have been many distinct variations in the laws introduced.159 For example, the influential New Zealand law put more emphasis on procedures,160 but Brazil’s is in many ways much more detailed and quite comprehensive in its coverage, with well-defined sanctions and much more emphasis on numeric fiscal rules to guide fiscal policy.
In practice, the experience of emerging countries in introducing fiscal responsibility laws (FRLs) has been quite mixed and suggests some points worth considering when introducing such legislation. First, the need for the law will depend on a country’s legal tradition.161 Much depends on the relative powers of the legislative and executive branches. Where the executive branch is powerful, budget reforms can be introduced by regulation or by amendment without introducing new legislation. Hence in countries following the Westminster model, fundamental budget reforms have been introduced and once proven are endorsed by changes in the law. Where the legislative branch is more powerful, such as in many continental European countries, fundamental changes are impossible without changes in the law. The important point is that for many emerging economies, a new legal framework should not be considered a precondition for undertaking reform. However, when the basic budget framework law is considered to be deficient and when there is a need for a clear demonstration effect and a political declaration in support of reform, it may prove useful to introduce a new budget system law before considering a full FRL. The new Public Finance Management and Control Act of Turkey reflects such considerations and incorporates many elements of a FRL (Box 52).
Second, it should be noted that in the New Zealand case, legislation followed rather than led budget system reforms. In many ways, the incentive was to fill gaps in existing legislation to cover new procedural and fiscal management reforms that had already been introduced. Therefore, in some cases it might be preferable to consolidate such reforms into a more comprehensive budget system law rather than to introduce special legi\slation. New Zealand is in fact following this path by repealing the Fiscal Responsibility Act and folding key features of that act into a revised version of the more comprehensive 1989 Public Finance Act to create a Public Finance, State Sector Management Act (Cullen and Mallard, 2003).
Third, merely adopting new legislation will not automatically bring reform. Typically, an FRL requires a strengthened PEM system to meet the new reporting requirements and enhanced controls over fiscal mismanagement. Most legislation of this nature provides for a transition period to allow these systems to be strengthened to meet the expanded accountability requirements. It would be imprudent to adopt new legal requirements without putting these improved PEM systems in place. From this perspective, the FRLs are a double-edged sword. They have the advantage of political visibility and hence serve the objective of inspiring confidence in a country’s fiscal management, especially in international markets. At the same time, failure to adhere to the law is equally visible and hence can work to destroy confidence in fiscal management. To minimize the risks, it is important to anchor the new budget system reforms on a firm PEM platform (the elements of which are outlined in Sections V and VI).
The Key Lessons for Budget Reform
Here are the key lessons to be learned from the FAD’s experience in providing technical assistance for introducing and sustaining the move from one budget model to another.
Turkey’s Public Financial Management and Control Law
This landmark law, passed in December 2003, reorients Turkey’s very traditional line-item budgets to a more performance-oriented basis, including by the following measures:
The law introduces the basics of strategic management and performance-based budgeting with the need to define strategic goals/missions and measurable objectives; public administrations are required to base their budgets on programs and projects related to their strategic plans. (Article 9)
The State Planning Office has been charged with introducing this approach and determining the strategic planning calendar. Public administrations prepare their budgets on a performance basis and in accordance with their strategic plans. Ministers are required to inform the public about the goals, objectives, strategies, and annual performance plans in the first month of the fiscal year.
Strategic plans are set in a medium-term program and must be consistent with the medium-term fiscal strategy prepared by the MoF, which includes targeted deficit and borrowing requirements. (Article 16)
There is a requirement for public administrations to measure performance according to predetermined indicators and to employ these indicators in monitoring and evaluating this process. (Article 9)
The performance indicators are set in a consultative process by the MoF, the State Planning Office, and relevant public administrations.
The MoF is authorized to review and check the consistency of performance indicators and strategic plans.
Performance audits are to be carried out on the basis of these indicators, and the mandate of the Court of Accounts (the supreme audit institution) is extended from financial audits to include value-for-money audits.
One of the fundamental principles of the public finance framework is that it should be administered to ensure the accountability of public officials. (Article 5)
Head administrators are to be accountable for performance. (Articles 10–11) They are required to prepare reports to explain their activities in line with the strategic plans and performance programs, according to determined performance indicators. Reasons for deviations are to be explained. (Article 41)
Based on these reports, the MoF presents a General Accountability Report to the Court of Accounts and makes it public. The Court of Accounts submits to the National Assembly its evaluation report on the General Accountability Report, accompanied by its opinions. This is discussed by the National Assembly along with the Government Budget Bill for the next fiscal round. (Article 42)
First and foremost, do not underestimate the level of management skills required. Who is going to manage the reform process? Who is going to manage the new budget system being introduced? Clearly addressing these questions can make a key difference in emerging countries where there is no great depth of managerial expertise in government.
Properly sequence the reforms. Management capacities must be strengthened as a prerequisite to devolving management autonomy. The devolved budget management model must rest on solid management foundations, especially at the agency level.
Begin modestly and do not be too ambitious. In design, a gradualist rather than a “big bang” approach is usually most appropriate. In implementation, a serial approach is preferred over an attempt at blanket coverage. Rather than seeking to use advanced technologies, making do with what is available and familiar may pay the highest dividends, at least initially. The relevant lesson from public sector reforms that have sought to install fully integrated FMISs (financial management information systems) is that such complex systems are often beyond the immediate capacities of those who must use them and the process of computerizing administrative procedures ends up deflecting resources away from more fundamental managerial reform.
Identify the right management teams. Management teams must inevitably be allowed some discretion. The practical limits of holding managers fully accountable for all dimensions of their agency’s performance, however, imply that there is some risk that this discretion will be misused. It is important that the change-management teams share common objectives that are fully congruent with those of the government. The more fully the government can trust the management teams, the more likely the reform is to succeed. It may seem daunting to find managerial leadership with common vision, technical competence, authority to spearhead the reform, and a full commitment to the process. But the fact is such leadership has been found in many countries, which offers living proof that in budget reform the human factor cannot be neglected.
Assess the change-management capacity, and design technical assistance accordingly. It may be necessary to develop a checklist that will enable some assessment to be made of this capacity and hence the likelihood of success in delivering TA. The key dimensions and relevant considerations for this risk assessment are reflected in Box 53.
Checklist for Assessing the Risks in Delivering TA for Budget Reform
Are the agents of change well identified?
How deep in the administration is the recognition of the need for change?
Is this recognition at the government level, the level of the minister of finance, or lower?
How stable/established is the reform team?
Do the reformers have an adequate base of support?
Is there an adequate level of fiscal stability to ensure success and avoid a diversion of energies?
Is there sufficient political and administrative stability?
Can the up-front costs of reform be borne by the government in the short term?
Does the present system have basic levels of fiscal control and financial management to support reform?
Does the overall environment provide incentives to support reform?
What is the general level of managerial capacity to implement reform?
Is the regulatory framework adequate for reform, or does it need to be changed?
What is the general perception of the level of governance in the country?
How empowered are consumers to demand better performance from government agencies?
At first glance, the reform agenda described in this volume may appear quite daunting. However, each of the steps described—establishing a strong PFM base, organizing the reform process, investing in human resources, adopting a clearly phased strategy, and putting in place an enabling legal and institutional environment—has individual merits and payoffs in its own right. Moreover, other countries have taken these steps on the road to reforming their budget systems, and so there is encouragement as well as lessons to be derived from their experiences. The mere fact that performance budgeting reforms have been continued and extended in the countries that first adopted them should be a spur for those just setting out on this reform path.
The prescription for reform described here should not be considered unique or cast in stone. While this reform agenda has been distilled from the experience of the OECD countries, the fact is that all the more advanced countries started from different initial conditions and found their own solutions to the challenges inherent in reform. Over time, they modified and adapted these reforms to meet their own particular circumstances and specific political and economic environments.
It is also worth remembering that the last word in budget system reform has not been written, and most likely never will be. Even the most advanced performance budgeting systems continue to be subjected to new reform initiatives and experimentation. From this perspective, middle-income and emerging countries that are pursuing budget reform should recognize there is no perfect system that can be taken “off the shelf” and applied without adaptation. What appears to have worked in one environment may not work in theirs. Instead, embarking on reform should be viewed as a learning process for all participants, one that can be expected to continue for many years before bringing its full results.
At the same time, although the pay-off from reform may not be immediate, there should be no doubt that there are significant advantages to pursuing such reforms and significant risks to countries that fail to do so. Globalization has had important repercussions for market-based economies—for their private sectors but for their public sectors as well. The discipline of the global market limits the scope for private sector inefficiency but at the same time also offers incentives to increase efficiency. Globalization imposes similar discipline on governments, not only directly through the channel of increased market financing of public sector deficits and public sector investments, but also indirectly and no less forcibly. An internationally competitive private sector requires an internationally competitive public sector that can ensure basic infrastructure, security, public health, an educated workforce, and basic utilities and transportation.
Performance budgeting is an attempt to ensure greater efficiency in the provision of public services. By so doing, it not only contributes to the sustainability of fiscal policies but also removes constraints on private sector competitiveness. Experience shows that the ultimate results can be profound: though performance budgeting may commence narrowly, with a focus simply on promoting improved service delivery, it has often ended up fostering a fundamental review of the appropriate role of government and changing the ground rules for government operations.
See Schick (2001).
Scott (1996) analyzes PEM reforms in New Zealand, emphasizing some important elements of this change-management process.
For a discussion of the importance of the management capacity and ethic in this budget management model, see Schick (1998, pp. 130ff).
For example, the 1989 New Zealand Public Finance Act, which introduced major reforms in fiscal management, developed a set of principles of financial management that began with the clarification of strategic and operational objectives.
This is discussed more fully in Schick (2001).
See OECD (1996).
For a discussion of the case of Russia, see Diamond (2002a).
“Global commercial liberalization and the free flow of capital are exerting new pressures on systems of public governance. Recent experience shows starkly that the quality of public institutions and the trust in which they are held by economic players can have very demonstrable effects on the behavior of these markets. Public sector governance systems that induce loss of market trust impose costs not only directly on their domestic economies, but more generally as they reduce global growth rates below potential.” (Schiavo-Campo and Tommasi, 1999, p. 343).
For a commentary on some developments in this rapidly developing field, see the commentary and references contained in OECD (2001).
See, for example, the summary of various fiscal responsibility laws contained in Baldacci and Corbacho (2004).
For example, the New Zealand act sets out five principles for responsible fiscal management, including a requirement to reduce debt to a “prudent level” and maintain it at that level. The law does not define the prudent level, which is left for the government to set.
See discussion and description of various traditions in Lienert and Jung (2005).