Using Political Economy Analysis to Inform the Sequencing of PFM Reforms

Early Findings from the Bangladesh PEIR

Alma Kanani, Sr. Economist, South AsiaFrom Diagnostics to Action: Sequencing and Politics of PFM,

WB Seminar, March 21st, 2008

Outline

Why undertake PE analysis on PFM Scope of PE Analysis Political Economy and Institutional Analysis at

the three levels of budget outcomes – an application in the case of Bangladesh

What does the PE analysis tell us about PFM institutions and PFM reforms

How to use it to inform strategy and actions Concluding Remarks

Why undertake PE Analysis?

The main elements of PFM are both political and technical. Changes in the way public resources are allocated and used involve

powerful winners and losers. Countries seem to pursue PFM reforms for a long time with

marginal results or no fundamental change in budget management practices – the case of some African countries, Bangladesh.

Countries engage in formulation of medium/long term strategies for PFM reform that are very technical in nature.

Bank ESW rarely uses PE analysis to inform its often politically charged policy and institutional reform recommendations.

Reform sequencing is country specific. Some general principles may apply but they may take a different place in different settings. One needs to understand the dynamic of the budget process and changing circumstances on a continuous basis.

The scope of PE analysis

Distinguish between PE Analysis of the budget process and PE analysis of the PFM reform. PE Analysis of the budget process focuses on the role

and interaction of the main actors, including political actors, with substantial influence over budget policy making and other budgetary decisions and ultimately budget outcomes.

PE analysis of PFM reforms uses the above to determine who are the potential winners and losers of proposed reforms and define a politically feasible strategy/course of action.

Both are complementary.

PE analysis - the budget process

Tries to address the questions: who are the players that influence budget outcomes at

three levels -- aggregate fiscal discipline, allocative and technical efficiency?

What are the formal and informal institutions/processes, (including political and administrative) that shape their behavior in making decisions about allocation and use of public resources?

What are the key failures and how can processes be improved in a way that is politically feasible?

PE analysis - the budget process in Bangladesh Aggregate fiscal discipline

Figure 3: Recent Trends in Overall Budget Deficit

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Outcome – good fiscal discipline, lowering fiscal deficits and sustainable domestic financing.

The analysis looks at key institutional arrangements for maintaining fiscal discipline:

Control over fiscal aggregates Use of macroeconomic programming Legal limits on borrowing and

spending Ex ante agreements in the executive

or legislature Accountability for budget

performance –ex-post Comprehensiveness

Conclusion: Centralized decision making at the powerful MOF, and early consensus on budget aggregates among the main players is crucial to these results, in the context of weak accountability and shortfalls in comprehensiveness.

Figure 4: Recent Trends in Deficit Financing

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Effective Fiscal Discipline Index and Inflation – cross country evidence

UAE 90s USA 90s

Korea 90s

Indonesia 90-97

Egypt 90s

Lebanon 90s

NZ 94-98

Turkey 90s

Morocco 90s

Kuwait 90s

Tunisia 90s

Brazil 85-94

Egypt 80s

Brazil 64-84

Brazil 95-99

Jordan 90s

Iran 90sAlgeria 90s

Yemen 96-00

Bangladesh 01-06

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Effective Aggregate Fiscal Discipline Index

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PE analysis - the budget process in BangladeshAllocative Efficiency-Strategic prioritization

Outcome: Broad inter-sectoral allocations are in line with strategic priorities The analysis looks at institutional arrangements for allocative efficiency:

Prioritization Participation of line agencies Flexibility of line ministries Breadth of consultations Comprehensiveness Accountability Program evaluation

Conclusion: The domination of central agencies, such as MOF and Planning and a limited role of the line ministries and the Parliament to make substantial changes maintain broad allocations in line with the stated strategic priorities.

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Effective Allocative Efficiency Index cross country evidence

UAE 90s

USA 90s

Korea 90s

Indonesia 90-97

Egypt 90s

Lebanon 90s

NZ 94-98

Turkey 90s

Morocco 90s

Kuwait 90s

Tunisia 90s

Brazil 85-94

Egypt 80s

Brazil 95-99

Jordan 90s

Iran 90s

Algeria 90s

Yemen 96-00

Bangladesh 01-06

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Overall Allocative Efficiency Index (Log Scale)

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PE analysis - the budget process in BangladeshOperational Efficiency

Outcome: Very weak operational efficiency

The analysis looks at institutional arrangements for operational efficiency

Agency autonomy Merit based recruitment and

promotion Accountability for performance Predictability of resource flow Average tenure of line agency

Managers Competitiveness of salaries Resource availability for day to

day operations Conclusion: Low scores on all of

these dimensions, especially on accountability and merit based rec. and prom. make these the main issues to be addressed.

Capital (ADP) Budget Deviation(Actual from Budget)

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1999 2000 2001 2002 2003 2004 2005 2006

What does the PE analysis tell us about PFM institutions and prospects for reform?

Institutional arrangements for PFM are highly influenced by the political developments and the political structure: A high degree of political fragmentation makes the alignment

of interests very difficult. A long and difficult way to a democratic system of

governance (1970-1991) does not promote establishment of well functioning institutions.

Nature of political parties (patronage systems and rent seeking) does not provide incentives for the politicians to focus on long term reforms with higher social returns (such as ACSR)

Limited degree of institutionalization of the political process does not provide incentives to the politicians to follow the rules but rather bent them to the benefit of their political game.

The highly central character of the parties means that top politicians have little interest in devolving power in the administration of policies and resources.

The Result…

A very centralized administrative and PFM structure. The system manages to deliver on more visible results, such as

fiscal discipline and broad budget allocations towards important programs.

Weak operational efficiency - the weakest aspect of the PFM systems, which requires a certain degree of autonomy, decentralization and greater accountability.

Weak accountability institutions. A system that fails to deliver in less visible and not easily

observable quality dimensions of public service. PFM reforms take a long time to produce any significant results

and fundamental change in the way policy is formulated and implemented.

PE Analysis – PFM reformsFrom analysis to actions To advance on PFM in a more fundamental way

there is a need to broaden the constituency for reform: Within the Government:

Initially support the group of technocrats in MOF and the line ministries.

Begin building some ownership for reform with the political class (changes in the current political arena might present an opportunity).

Outside the government— Align with segments of the private sector/civil society

that are requesting change. Educate the media. Supreme Audit Institutes.

PE Analysis – PFM reformsFrom analysis to actions Anchoring PFM reforms on the MTBF approach has proved

beneficial to broaden their constituency within the Government: Positive incentives for the line ministries –greater autonomy. Engagement of senior level management and more

progressive politicians in the budget formulation process. Focus on performance.

Increase transparency for engaging with groups outside the Government: Improving quality of budget data at all stages is crucial (i.e)

modernization of accounting systems, IFMS. Publish audit results. Building capacity at certain think tanks/civil society and

media groups to review budgets, especially to provide info on how they affect public service delivery.

Concluding Remarks

Understanding the political economy factors that affect the structure and performance of PFM is crucial to: Design a well sequenced PFM reform strategy. Understand the key constraints and needed remedies,

which may lie outside the PFM arena. Adjust expectations for achieving desired results. Use the various instruments in the right way. Build necessary partnerships and alliances to push

reforms. Reform sequencing is country specific. General principles

may apply, but they may take a different place in different settings. One needs to understand the dynamic of the budget process and changing political circumstances on a continuous basis.