Public Finance Analysis and Management: An Overview Anand Rajaram, PRMPS PFAM Course PREM Learning Week 2007 April 23, 2007

Outline 1.Public Economics and Public Finance Theory 2.Some Empirical Observations 3.The Evolution of Bank work on Public Finance –the link to lending and CAS –From policy to management –Response to fiduciary concerns –Measuring PFM performance 4.The Current State of Play 5.Future Directions

1. Economics of the Public Sector Mercantilist view – govt. promotion of trade and industry (colonies) Adam Smith –invisible hand guides markets to provide goods and services, competition weeds out inefficiency Subsequent recognition of market failures- barriers to entry/exit, public goods, externalities, incomplete markets, information and coordination problems, macro-disequilibrium (Stiglitz)

Adam Smith on the Role of the State The three duties of the sovereign – –protecting society from the violence and invasion of other societies – by maintaining a standing armed force –protecting every member of society from injustice or oppression by others – by establishing an exact administration of justice –erecting and maintaining those public institutions and public works which, though they may be in the highest degree advantageous to a great society..the profit could never repay the expense of any individual or small number of individuals.. to erect or maintain. chiefly for facilitating commerce (roads, bridges, canals, harbours, etc.) and for promoting education So Smith anticipated public goods but not other forms of market failure (externalities, incomplete markets, etc.) No mention of social protection or transfers

Role of Modern Government To use regulation, taxation and public provision/financing to correct for market failures, improving the efficiency of the economy and overall growth To use public policy instruments to improve equity and protect the vulnerable Need to take into account the scope for government failure Political and economic ideology determines size and scope for government (ISI, welfare state, urbanization, health pandemics, regional conflicts, ODA)

The Theory of Public Finance Government functions: allocation, distribution and stabilization (Musgrave) Revenue is needed to finance public goods and services, to redistribute income, and to regulate macroeconomic balances Raising revenue is not costless – disincentive effects of taxation and administrative costs of collection Efficiency requires taxing goods that are inelastic, tax consumption rather than labor or capital, use broad based taxes Debt is a form of deferred revenue raising (Ricardian equivalence)

Public spending Theory offers some general principles for expenditure policy –Public expenditure is inefficient if it crowds out private expenditure –Some kinds of goods and services would be welfare and growth enhancing – those that markets fail to produce –Equity can be enhanced by public provision of g&s to the poor or other target groups

2. Some Empirical Observations

Growth of Government – a relatively recent phenomenon

Revenue and Expenditure Vary With Income (% of GDP, 2002) Total RevenueTotal Expenditure Income Level GG CG Low Income Lower Middle-Income Upper Middle-Income High Income Note: Cash basisGG=General GovernmentCG=Central Government

Across Countries – Financing Sources also vary

Aid Sustains Spending in some regions (In Percent of GNI)

Public spending and sector outcomes are often weakly related (WDR 2004)

Missing variables Intuitively, differences in policies and institutions could explain the weak expenditure-outcome link across countries WDR 2004 identified some core elements: –Budget policy and management –Organization of tiers of government –Quality of public administration Other factors – role of private sector

Typical budget pathologies in LICs Overambitious development plans, unclear policies Unrealistic budgets No disciplined link between policy, plan and budget Incremental budgeting, no forward perspective Non-transparency - extra-budgetary funds, lack of comprehensive budget framework Budget execution marred by unpredictable allocations, including interruptions in flow of funds Symptoms of problems: arrears in payments to suppliers, unpaid bills to utilities, incomplete projects, lack of maintenance of assets, poor services Tax evasion

3.Evolution of Bank PER work In the 1980s, focus limited to investment budget – identifying “white elephants” With SAL and budget support, broader concern for overall budget in the 1990s By late-90s, growing focus on PEM and reduced focus on policy Early 2000s, “fiduciary” concerns and development of CFAAs and CPARs and HIPC expenditure tracking indicators Sub-national public finance work in large countries (India, Indonesia, China, Brazil)

Role of the PER The PER provides Bank management and Board with a view on the quality of budget policy and management in a country Used to determine if “budget support” is appropriate –Whether policies are sustainable or efficient –Whether the budget is aligned with policy objectives –Whether budgetary processes support effective implementation and policy outcomes To advise the government on options for reform of policy and/or management To support government in designing and implementing reform and building capacity

Scope of PERs Typical PER - a brief discussion of overall macro (trends in growth, inflation, revenue and deficits) Reference, perhaps, to an IMF-determined fiscal framework with medium term aggregate deficit, revenue and expenditure targets So, fiscal (deficit) policy is given by IMF program PER may then turn to discussion of sector expenditures and/or budget formulation and execution, MTEF, etc. No strong links established in many PERs between budgets and growth objectives No true long term perspective to guide fiscal policy

PERs Differ in Coverage and Approach In general, recent PERs expected to cover more issues Relative emphasis on policy or management or special topics may differ across PERs Differences also in degree of “participation” by government counterparts Different approaches to integrating with related products – CFAA and CPAR PERs beginning to take the form, not of a single report, but a sequence of complementary analytical modules to support government reforms

Examples of PERs – varied formats PIR as a supplement to Customized BM report: Russia The PEM and the PEP: Mozambique (2001), (2003) PE Reform support to MTEF: Albania (2001) Bank supplement to Govt PER: Malawi, Tanzania, Zambia PEIRs: Turkey, Macedonia, Croatia, Bosnia Annual PERs with regional supplement – Ethiopia (2001) Annual PE process report: Uganda PERs w/Intergovt.Fiscal – Czech,Thailand, Kazakh,Bosnia Provincial PERs – Punjab (Pakistan), Maharashtra (India) Indonesia, China Integrated PEM reports: Philippines, Iran, Zambia

PER coverage,

Have Bank-Fund roles been effective? Fund leads on “stabilization” issues and forms view on aggregate fiscal stance Fund has greater capacity on revenue policy and administration while Bank does finance tax admin. projects Bank leads on “allocative” and “distributive” issues w.r.t. budgets Both IFIs provide advice on PEM But this form of collaboration has its limitations and does not serve clients well

4. Current State of Play In recent years, governments have complained about fiscal policy – demand for fiscal space for growth IMF papers on public investment and fiscal policy concluded that changes in fiscal rules would be risky and unwarranted Bank asked to provide a developmental perspective on fiscal policy and scope to better support growth Two papers to Dev. Committee lays out our view

5. Future Directions PRMVP speech underlined importance of fiscal work Bank will adopt a “public finance” perspective, encompassing revenue, aid, debt and expenditure New growth diagnostics approach (Rodrik, Hausmann) provides basis to link public expenditure and fiscal policy to growth Efficiency analysis and incidence work at the sector level will be key to improving advice to governments – including exciting new experimental approaches at MIT poverty lab

Annex Join the Public Finance thematic group to hear about BBLs and to have access to a community of practitioners Visit Public Finance website at: NANCE/0,,menuPK: ~pagePK:149018~piPK:149093~theSitePK: ,00.html?