Reform to Budget Institutions Reform to Budget Institutions in Latin Americain Latin America

Carlos ScartasciniCarlos Scartascini

Senior Research EconomistSenior Research Economist

Inter-American Development BankInter-American Development Bank

An Introduction to the Open Budget InitiativeAn Introduction to the Open Budget Initiative

The International Budget ProjectThe International Budget Project

Washington, DC - May 29Washington, DC - May 29thth, 2007, 2007Opinions expressed in this presentation do not necessarily reflect the view of Bank management Opinions expressed in this presentation do not necessarily reflect the view of Bank management or member countries.or member countries.

The Budget ProcessThe Budget Process

The budget is the main tool for allocating scarce The budget is the main tool for allocating scarce public resources.public resources.

The bThe budget process udget process is the arena where decisions is the arena where decisions regarding the use of public funds take place, where regarding the use of public funds take place, where society faces trade-offs regarding the use of its society faces trade-offs regarding the use of its resources and (ideally) allocates them to their most resources and (ideally) allocates them to their most efficient uses.efficient uses.

APPROVAL

LEGISLATIVO

Legislative Branch

Executive Branch

DRAFTING

Executive Branch

Finance Ministry

Line Ministries

Legislative Branch

Finance Ministry

EXECUTION & CONTROL

The Budget Process

Budget Project

Approved Budget

Line Ministries

Executive Branch

Legislative Branch

Control Entities

Executed Budget

Changes

The Budget ProcessThe Budget Process

Budget decisions are the result of a collective process Budget decisions are the result of a collective process involving a variety of political actors, each with their involving a variety of political actors, each with their own motivations and incentives.own motivations and incentives.– FoFor example, legislators could have the incentive to bring r example, legislators could have the incentive to bring

benefits to their district to increase their chance of benefits to their district to increase their chance of reelection.reelection.

– Finance Ministers could be interested in keeping Finance Ministers could be interested in keeping expenditures under control. expenditures under control.

– Line Ministers could be interested in fostering public Line Ministers could be interested in fostering public projects in their area of domain.projects in their area of domain.

– Interest groups could lobby for obtaining transfers from Interest groups could lobby for obtaining transfers from government.government.

The Budget ProcessThe Budget Process

Given the prevailing preferences of the participants, Given the prevailing preferences of the participants, under some institutional arrangements, the budget under some institutional arrangements, the budget process may lead to a number of potential problemsprocess may lead to a number of potential problems Electoral budget cyclesElectoral budget cycles Short time horizon of politiciansShort time horizon of politicians Principal-agent problems (private benefits of those who Principal-agent problems (private benefits of those who

participate in the process)participate in the process) The common pool problemThe common pool problem

The Common Pool ProblemThe Common Pool Problem

Stems from combination of two key features of Stems from combination of two key features of public budgets:public budgets: Government programs generate concentrated benefits, but Government programs generate concentrated benefits, but

are financed from common pool of resources.are financed from common pool of resources. The budget is the result of a collective decision-making The budget is the result of a collective decision-making

process, involving a variety of agents (legislators, the process, involving a variety of agents (legislators, the finance minister, spending ministers, etc.)finance minister, spending ministers, etc.)

Since most of these agents represent geographical or Since most of these agents represent geographical or sectoral interests, under some institutional sectoral interests, under some institutional arrangements the budget process may lead to over-arrangements the budget process may lead to over-utilization of the common pool, thus to excessive utilization of the common pool, thus to excessive spending or deficits.spending or deficits.

The Role of Budget InstitutionsThe Role of Budget Institutions

The way the actors interact in the budget process is The way the actors interact in the budget process is affected by the nature of budget institutions, which affected by the nature of budget institutions, which impose restrictions on their actions, and define the impose restrictions on their actions, and define the rules of engagement among them.rules of engagement among them.

Budget InstitutionsBudget Institutions are the set of rules, procedures are the set of rules, procedures and practices according to which budgets are and practices according to which budgets are drafted, approved and implemented (Alesina and drafted, approved and implemented (Alesina and Perotti, 1996).Perotti, 1996).

These rules may take various forms, like numerical These rules may take various forms, like numerical rules, procedural rules, and transparency rules.rules, procedural rules, and transparency rules.

The Role of Budget InstitutionsThe Role of Budget Institutions

NumerNumericalical rules: rules: laws and/or regulations which establish ex laws and/or regulations which establish ex ante constraints on deficits, debt, and/or expenditures. They ante constraints on deficits, debt, and/or expenditures. They may be conducive to fiscal discipline by forcing agents to may be conducive to fiscal discipline by forcing agents to internalize the budget restriction.internalize the budget restriction.

Hierarchical procedures:Hierarchical procedures: norms and regulations that give norms and regulations that give primacy in the bargaining over the budget to a particular primacy in the bargaining over the budget to a particular agent (set of agents). They may be conducive to fiscal agent (set of agents). They may be conducive to fiscal discipline by given more power to those agents with political discipline by given more power to those agents with political incentives to keep finances under control.incentives to keep finances under control.

Transparent procedures:Transparent procedures: norms and regulations that establish norms and regulations that establish the conditions under which budgets are prepared and the conditions under which budgets are prepared and presented to society. They may be conducive to fiscal presented to society. They may be conducive to fiscal discipline by increasing the chances of enforcement. They discipline by increasing the chances of enforcement. They may also limit agency problems by increasing accountability may also limit agency problems by increasing accountability to voters.to voters.

Do Budget Institutions affect fiscal Do Budget Institutions affect fiscal performance?performance?

International experience suggests that they doInternational experience suggests that they do US: States with more stringent balanced budget rules US: States with more stringent balanced budget rules

have better fiscal outcomes (lower deficits, lower debt, have better fiscal outcomes (lower deficits, lower debt, adjust more quickly to adverse shocks) (Poterba, 1995)adjust more quickly to adverse shocks) (Poterba, 1995)

EU: J. von Hagen (1992, 1995) built an index of EU: J. von Hagen (1992, 1995) built an index of Budget Institutions and fBudget Institutions and found that ound that more hierarchical more hierarchical Budget Institutions reduce deficits and debt, without Budget Institutions reduce deficits and debt, without affecting capacity to stabilize output.affecting capacity to stabilize output.

Looking at the role of budget and fiscal institutions has Looking at the role of budget and fiscal institutions has provided invaluable insights for understanding fiscal provided invaluable insights for understanding fiscal results for Latin America.results for Latin America.

The Latin American ExperienceThe Latin American Experience

First studied by AHHS (1996): more restrictive, First studied by AHHS (1996): more restrictive, hierarchical and transparent budget institutions hierarchical and transparent budget institutions are associated with smaller deficitsare associated with smaller deficits

Result confirmed by recent work by Filc and Result confirmed by recent work by Filc and Scartascini (2005, 2006) using a much broader Scartascini (2005, 2006) using a much broader index of budget institutions for a sample of 18 index of budget institutions for a sample of 18 Latin American countries, as well as one of 29 Latin American countries, as well as one of 29 developing countries.developing countries.

The impact of Budget Institutions is robust, and The impact of Budget Institutions is robust, and economically importanteconomically important

Filc and Scartascini (2005)

MéxicoArgentina

Bolivia

ChileColombiaUruguay

Perú

Brasil

El Salvador

Surinam

Paraguay

Venezuela

Guatemala

Ecuador

Panamá

Costa Rica

Honduras

Nicaragua

Republica Dominicana

-0.05

-0.04

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

Pri

mar

y b

alan

ce o

f ge

ner

al g

over

nm

ent

(% o

f G

DP

)

The Latin American ExperienceThe Latin American Experience

Index of Budget Institutions

Reforms to Budget InstitutionsReforms to Budget Institutions

Results found in the literature suggest that countries Results found in the literature suggest that countries would benefit from reforming their budget institutions would benefit from reforming their budget institutions by adopting more restrictive rules, more hierarchical by adopting more restrictive rules, more hierarchical procedures and more transparent practices.procedures and more transparent practices.

During last two decades, countries in Latin America During last two decades, countries in Latin America actively engaged in process of reform. Reform efforts actively engaged in process of reform. Reform efforts have come in different waveshave come in different waves– Early 1990s, main feature was adoption of integrated financial Early 1990s, main feature was adoption of integrated financial

administration systems, which improved transparency, as well as the administration systems, which improved transparency, as well as the flow of information available to the budget authoritiesflow of information available to the budget authorities

– Since 2000, one of the main features has been the adoption of Since 2000, one of the main features has been the adoption of numerical fiscal rules, often within the context of broader fiscal numerical fiscal rules, often within the context of broader fiscal responsibility laws (7 countries adopted FRL’s in this period)responsibility laws (7 countries adopted FRL’s in this period)

– More recently, increased emphasis on performance budgeting More recently, increased emphasis on performance budgeting (shifting the focus from fiscal sustainability to efficiency of public (shifting the focus from fiscal sustainability to efficiency of public expenditures)expenditures)

Reforms since 1990Reforms since 1990

Source: Filc and Scartascini (2006)R(X,Y) means that the Fiscal Responsibility Law included restrictions to X and Y.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Argentina N, F U,E1 R(N,C,T),S P,r(c) ,S,E,F2 r(n) ,S R(N,S,C)

Bolivia S U

Brazil N R(N,S,T),P

Colombia f 3 F4 C N S R(N,P,T)

Chile R5(N,C) e 6, T

Costa Rica U,A

Ecuador U E7 N C R(N,P,C,T) T r(n)

El Salvador U A

Guatemala P,N,U

Honduras P,U

Mexico C C8,P,T

Nicaragua S,F9,A P

Panama U R(N),S,T r(n) P,U

Paraguay e 10 U P P11

Perú U R(N,P,C,T) r(n) ,C,T

Dominican Rep F12 T

Uruguay U,E13

Venezuela C,U P R(N)14

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Notes:

Table 5.1 Summary of fiscal reforms in Latin America

Italic lower case means that the previously established reforms were reversed or the restrictions weakened.

N: Numerical rules; C: Contra-cyclical Fund; P: Multiyear framework; R: Fiscal Responsibility Law: Subnational Govts; U: Single account; E: Increase in Executive power; F: Increase in power of Finance Ministry; T: Transparency, and; A: Principles of transparency.

Numerical RestrictionsNumerical Restrictions

Fiscal Responsibility LawVenezuela

Uruguay

Surinam

Rep. Dominicana

Fiscal Responsibility LawPerú

Paraguay

Fiscal Responsibility LawPanamá

Nicaragua

Méjico

Multi-annual frameworkHonduras

Guatemala

El Salvador

Fiscal Responsibility LawEcuador

Costa Rica

Structural Balance RuleChile

Fiscal Responsibility LawColombia

Fiscal Responsibility LawBrasil

Bolivia

Fiscal Responsibility LawArgentina

Main reformHigh restrictions

Medium restrictions

Low restrictions

Country

Procedural RulesProcedural Rules

Venezuela

Uruguay

Surinam

Rep. Dominicana

Perú

Paraguay

Panamá

Nicaragua

Méjico

Honduras

Guatemala

El Salvador

Ecuador

Costa Rica

Chile

Colombia

Brasil

Bolivia

Argentina

High hierarchyMedium hierarchyLow hierarchyCountry

Transparency RulesTransparency Rules

Venezuela

Uruguay

Surinam

Rep. Dominicana

Perú

Paraguay

Panamá

Nicaragua

Méjico

Honduras

Guatemala

El Salvador

Ecuador

Costa Rica

Chile

Colombia

Brasil

Bolivia

Argentina

High transparency

Medium transparency

Low transparency

Country

The Path of ReformsThe Path of Reforms

Source: Filc and Scartascini (2006).

Figure 5.1 The path of the reforms

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Evolu

tion

of

Insti

tuti

on

s

Fiscal Rules

Procedures Rules

TransparencyRules

Situation 1990

Situation 2005

Source: Authors' calculations

Examples of Some Recent ReformsExamples of Some Recent Reforms

Not Not every country has had the same rate of success every country has had the same rate of success with their reforms.with their reforms.

For example, Argentina, Brazil, Chile, and Peru For example, Argentina, Brazil, Chile, and Peru introduced numerical restrictions in order to improve introduced numerical restrictions in order to improve their fiscal results.their fiscal results.

While AR, BR, and PE did it using Fiscal While AR, BR, and PE did it using Fiscal Responsibility Laws, Chile introduced a Structural Responsibility Laws, Chile introduced a Structural Balance Rule.Balance Rule.

BrazilBrazil adopted a very comprehensive FRL, imposing adopted a very comprehensive FRL, imposing constraints not only at national level, but also at the constraints not only at national level, but also at the subnational level of government.subnational level of government.

Evolution of the Index of Budget Evolution of the Index of Budget InstitutionsInstitutions

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Year

Ind

ex o

f B

ud

get

In

stit

uti

on

s

Prom (AmLat)

Chile

Argentina

Perú

Brazil

Argentina

LatAmerica

Chile

Peru

Brazil

Results have been mixed at bestResults have been mixed at best

Chile has had the most success using the less Chile has had the most success using the less stringent type of norm.stringent type of norm.

Brazil: may be too early for definitive conclusions, Brazil: may be too early for definitive conclusions, but so far results have been encouraging.but so far results have been encouraging.

Argentina and Peru: Numerical rules component of Argentina and Peru: Numerical rules component of FRL’s has only recently been complied (partially) FRL’s has only recently been complied (partially) with.with.• FoFor example, Peru has complied with the deficits rule the r example, Peru has complied with the deficits rule the

last couple of years but has yet to comply with the rule that last couple of years but has yet to comply with the rule that limits the real increase of expenditures. Olimits the real increase of expenditures. Other aspects of the ther aspects of the law (e.g. multi-annual macro program, increased law (e.g. multi-annual macro program, increased transparency and budget cycle) have changed the dynamics transparency and budget cycle) have changed the dynamics of the budget discussions.of the budget discussions.

Electoral Budget Cycle in PeruElectoral Budget Cycle in Peru

Argentina: Deficits and the Fiscal Solvency Argentina: Deficits and the Fiscal Solvency LawLaw

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

1999 2000 2001 2002 2003

Cen

tral

gov

ernm

ent d

efic

it (

% o

f G

DP

)

Actual central government deficit

Deficit limit according to 2001 Fiscal Solvency Law

Deficit limit according to 1999 Fiscal Solvency Law

BBudget Institutionsudget Institutions Reform: Reform:ssomeome lessons learned lessons learned

Lesson 1: The business of reforming BI is is not Lesson 1: The business of reforming BI is is not an easy one.an easy one.

Lesson 2: When it comes to the design of Lesson 2: When it comes to the design of reforms, the devil is in the details.reforms, the devil is in the details.• In Argentina and Peru, some aspects of the law were very In Argentina and Peru, some aspects of the law were very

poorly designed.poorly designed.• ordinary law rather than special law (as in Brazil)ordinary law rather than special law (as in Brazil)• no enforcement mechanisms (in Brazil there are severe no enforcement mechanisms (in Brazil there are severe

penalties including jail for non-compliance, and penalties including jail for non-compliance, and automatic trigger mechanisms to adjust behavior when automatic trigger mechanisms to adjust behavior when targets are approached)targets are approached)

• conditions for escape clauses in rules not clearly conditions for escape clauses in rules not clearly specified.specified.

BBudget Institutionsudget Institutions Reform: Reform:ssomeome lessons learned lessons learned

Lesson 3: While it may be tough to get these reforms Lesson 3: While it may be tough to get these reforms passed, it is even tougher to make them stick.passed, it is even tougher to make them stick.• Adequate implementation and enforcement requires an external enforcer Adequate implementation and enforcement requires an external enforcer

(such as a capable and independent judiciary) or stakeholders interested (such as a capable and independent judiciary) or stakeholders interested in enforcing the rules, and powerful enough to do so. in enforcing the rules, and powerful enough to do so.

Lesson 4: The success of reforms depends on the Lesson 4: The success of reforms depends on the institutional context in which they are embedded.institutional context in which they are embedded.

A good understanding of the policymaking process (i.e., of A good understanding of the policymaking process (i.e., of the key political actors, their incentives and capabilities, the key political actors, their incentives and capabilities, the ways they interact, the political transactions they the ways they interact, the political transactions they engage in) is a key ingredient for the successful design and engage in) is a key ingredient for the successful design and implementation of reforms.implementation of reforms.

Understanding the Political Economy of the Budget Understanding the Political Economy of the Budget Process is our current research agenda.Process is our current research agenda.