Traditionally, countries managed their budgets in a highly centralized fashion. They created a set of policy objectives—albeit usually poorly articulated with little quantification—and then allocated resources to meet these objectives. The focus was on the resources being distributed and on the centralized control and compliance devices that ensured that resources reached their intended destinations. Typically, however, there was little follow-up to see whether spending departments actually performed as expected.
But, beginning in the United States, and spreading to nearly all them by the early 1980s, advanced economies began to rethink how they managed their budgets. They experimented with allowing greater flexibility in return for a new emphasis on performance and accountability.
Just what did that mean in terms of managing budgets? Within a hard budget constraint, performance budgeting gave spending agencies greater scope to access and use funds, largely by allowing them to reallocate funds between types of resources that had previously been controlled as line-item expenditures. Unnecessary constraints on resource management were removed, and agencies and managers were granted greater freedom to make operational decisions. Spending agencies also gained greater certainty that the funds they needed would be available. In many advanced economies, the shift to performance budgeting was accompanied by more medium-term budget planning. Typically, three- or five-year budget frameworks replaced the customary one-year fiscal targets.
But this greater freedom and predictability came with strings attached: agencies and managers were held more accountable for outcomes. Performance budgeting was expected to pay off in greater efficiency and effectiveness.
The transition to performance budgeting also reflected a growing consensus in advanced economies that improved performance played a more crucial role in promoting a stable and healthy macroecon-omy than did detailed controls on resources. Experience suggested that cutting certain types of spending across the board was less effective than allowing managers to achieve efficiencies by adjusting their resource use on the basis of relative resource prices and changes in technology. As a result, the advanced economies increasingly moved to integrate budgeting with other management processes, develop new guidelines and methods for holding managers accountable for results, and design information bases and reporting systems that could enforce this accountability.
Getting there from here
The experiences that advanced economies have had in designing and implementing performance budgeting hold potentially valuable pointers for middle-income and emerging market countries looking to make a similar transition. Experience underscores the importance of taking an evolutionary approach, developing a broad consensus on the desirability of the change, placing budget reforms in an overarching reform strategy, ensuring adequate fiscal controls, and—perhaps above all—having in place essential management skills.
Taking an evolutionary approach. There is widespread agreement that modern budget systems must ensure control over expenditures, so that they are consistent with the budget law; stabilize the economy through timely and efficient adjustment mechanisms for the fiscal aggregates; and promote allocative and technical efficiency in service delivery by providing incentives for greater productivity.
To meet these requirements, the advanced economies avoided discrete jumps from compliance to performance models. Instead, they chose an evolutionary approach, progressively placing different emphases on the three requirements. More recently, many transition economies took a similar approach. As they emerged from compliance controls and initially faced severe macroeconomic instability, they adopted suitable budgetary policies and procedural adjustments that allowed them to review the efficiency and effectiveness of government operations and sequentially embrace elements of performance budgeting.
Advanced economies experimented with allowing greater flexibility in return for a new emphasis on performance and accountability.
Reaching consensus. Confronted with the prospect of a widespread and long-term deterioration in public finances and increasingly aware of the need to achieve fiscal sustainability, the advanced economies typically reached broad consensus on the need for reform. In addressing these structural problems, they also became aware of the limitations of traditional compliance-oriented budget systems.
Role of technical assistance
What should the IMF’s Fiscal Affairs Department counsel when a country asks for advice on whether to pursue a new generation of performance budgeting reforms? Undertaking a risk assessment and developing a checklist enable the department to determine whether the country has the resources needed to carry out such a fundamental institutional change and whether appropriate technical assistance can successfully be delivered.
Among other things, a checklist should ask the following:
How well are the agents of change identified?
How deep is the recognition of the need for change?
How far up in government is the need recognized—at the minister of finance level or lower?
How stable or established is the reform team?
Do the reformers have an adequate base from which to work?
Is there adequate fiscal stability?
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 existing system have basic levels of fiscal control and financial management to support reform?
Does the overall environment provide the incentives needed to support reform?
Is the general level of managerial capacity sufficient to implement reform?
Is the regulatory framework adequate for reform, or will it need to be changed?
What is the level of governance in the country?
How empowered are consumers of government services?
Can they demand better performance from government agencies?
At the same time, the wider use of more flexible budget management procedures convinced the authorities that ensuring macroeconomic stability and promoting a more efficient economy were complementary rather than competing objectives. As this view took hold, concerns deepened about whether traditional budget systems, based on short-term and detailed control of resources, were an effective tool for promoting public sector performance (which, by definition, focuses on the impact of those resources).
In the end, growing suspicion that the fiscal objective of achieving a stable economy was coming at the cost of poorer performance led many advanced economies to shift from instruments of simple macro control to budget systems that provided the means to manage performance.
Making budget reform a major part of an overall strategy. Once the need to reform the budget system was recognized and accepted, advanced economies commonly made this reform a part of the government’s fiscal strategy and a central element of government policy. As such, the reform initiative was “owned” and supported by all ministers, not just the ministry of finance or the budget office. This high-level commitment facilitated the required changes in administrative procedures and made central agencies more willing to devolve budget management.
Ensuring adequate fiscal controls. Before they moved toward a more flexible and decentralized budget model, however, all of the advanced economies had reached adequate levels of fiscal control. That meant delivering actual expenditures in line with the approved budget and adjusting fiscal aggregates if the macroeconomic environment changed.
All three aspects of performance budgeting—managerial flexibility, greater certainty in budget funding, and increasing pressure to perform—were essential. Allowing one element to slide threatened the success of the entire reform. In particular, giving greater flexibility to spending agencies without ratcheting up the pressure for improved performance made it more likely that budgeted funds would be used inefficiently.
Stressing management of the reform process. Even in advanced economies, reform programs had to be “engineered.” A reform plan needed to be formulated, an implementation strategy agreed upon, and implementation managed if the desired objectives were to be achieved and the reform initiative sustained. The reform program also had to be “sold” to the main stakeholders in the budget system. And, perhaps more important, a reform team had to be identified and empowered to carry out the reform. It is this aspect of the process—the management of change—that holds the most risk. Put another way, it is essential to focus on how the government shifts from a compliance culture to a performance culture.
Begin modestly and avoid “big bang” solutions. In designing the reform, take a gradualist approach. In implementation, use a sequenced rather than a blanket approach.
Lessons to be learned
What lessons, then, can be drawn from the advanced economies? Their experience seems to yield four clear messages:
First and foremost, never underestimate the management skills that will be required. Who will manage the reform process? Who will manage the new budget system? Effectively answering these questions can make a critical difference in emerging market countries where managerial expertise in government is in limited supply.
Second, sequence the reforms properly. Management skills must be strengthened before budget management can be devolved. Solid managerial foundations are essential, especially at the agency level.
Third, begin modestly and avoid “big bang” solutions. In designing the reform, take a gradualist approach. In implementation, use a sequenced rather than a blanket approach. And, when possible, make do with current technology rather than opting for more advanced technologies. The familiar is likely to pay dividends, at least initially.
Fourth, identify the right management teams. Performance budgeting involves allowing management teams some discretion. The combination of discretion and practical limits in holding managers fully accountable for all dimensions of their agency’s performance implies some risk. The team managing the transformation needs to share objectives that are fully congruent with the government’s. The more fully the government can trust the management team, the more likely the reform is to achieve its objectives.
Of course, it can be daunting to find managerial leadership that has the requisite vision, technical competence, authority to spearhead the reform, ability to sell the reform to those most affected, and commitment to the reform’s goals. But many countries have found the right people for the job, and their experience proves that the human factor can be the key to effective budget reform.
Copies of IMF Working Paper No. 03/33, “Performance Budgeting: Managing the Reform Process,” by Jack Diamond, are available from IMF Publication Services for $15.00 each. Please see page 166 for ordering details. The full text is also available on the IMF’s website (www.imf.org).