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Conversation with Shanta Devarajan, Chief VP, MENA, Economics, World Bank

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FitzFord:
Shanta, whose  condensed cv is a modest presentation of his career in Development Economics at Harvard University and the World Bank, will be with members of, and visitors to,  PFMBoard, will spend the coming Friday morning with us to discuss a crucial set of development issues that he has outlined in a brief note. Both the condensed cv and the discussion note will be posted as well. As usual, there will be exchanges of views, questions and answers that will continue until Thursday 26th. After that the conversation will be closed and remain available online.

Shanta's discussion topic: PFM and public service delivery

"Since the purpose of good public financial management is to improve the effectiveness of government, the discussion will focus at the other end, namely the delivery of public services and ask, how--if at all--PFM can improve their outcomes. First, I will question whether the activities that governments actually spend on are those that they should spend on. Using a simple, welfare-economics framework, I will show that most items in the government budget do not pass the test. In this context, strengthening PFM is like making the trains run faster...to the wrong station. Next, I will show that, even those government interventions that meet the welfare test often fail to deliver what they are supposed to because of (i) poor incentives in the service delivery system; and (ii) capture of public funds by political elites. In these cases, better PFM can help only if they change incentives in the same direction as is necessary to improve service delivery. Specifically, better monitoring of public expenditures can help if the information is shared with people who can influence decisions about service delivery. If it is shared with other government entities, it may increase their power over service beneficiaries and reinforce elite capture. Finally, better PFM for aid projects in an otherwise dysfunctional system rarely helps outcomes and may make matters worse, by increasing government's accountability to donors as opposed to its own citizens."

SDevarajan:
To get the conversation going, I thought I'd elaborate on the first point I made in my abstract: That governments frequently spend on things that they shouldn't be spending on.  As a principle, governments should spend on things that the private sector, left to its own devices, will not (otherwise, government would simply be crowding out the private sector and wasting the public's money).  In economics jargon, these goods and services are called public goods or goods with externalities.  The classical examples include national defense and lighthouses (although, with GPS technology, the latter have become irrelevant).  But clearly governments spend on more than national defense.  Two of the biggest expenditure items are education and health.  In each of these, there are public-good or externality elements, although there are private goods as well.  For instance, in education, the main benefit from education is that the student earns a higher wage, which is a private good.  There may also be an externality, such as the fact that society as a whole benefits from having a literate and numerate population.  However, governments typically finance and provide all of education, rather than just the externality (which should strictly speaking be addressed with a subsidy to education).  Furthermore, this externality is highest at the primary level, lower at the secondary level and lowest at the tertiary level.  Yet government spending per student is highest at the tertiary level.  This is an example of government spending on private goods (university education) with scarce public resources.  There may be an equity argument for government spending on university education, but this would imply governments should subsidize or give free tuition to poor students, not all students.  In fact, most of the students attending free public universities come from the richest quintiles of the population.  In short, government spending on higher education (sometimes amounting to 1-2 percent of GDP) has very little justification.  What then is the benefit of having PFM systems that track public spending in education closely?  Are we perpetuating a wasteful system?  Let the discussion begin....

Shanta

Napodano:
Hi, Shanta;

It is great that you start the conversation with a policy issue. One well-established criteria that discriminates a good PFM system from a mediocre one, is the capacity to link budget (and more in general public spending) to policy. Prime Minister Office, Ministry of Finance and the Cabinet collectively need to assess policy priorities, weigh spending options and expected results in and then have a budget that consolidate their policy choices.

To this end, I would like to pose the following question (Question #1):

What is your view on PFM reforms that promote performance-based budgeting in developing countries? After an initial enthusiastic start, only a few success cases have been recorded on a permanente basis. Was it premature for countries which do not have proper economic policies in the first place? Was the reform rejected by Governments with powerful vested interest?  Was too much emphasis on planning indicators a waste of Government attention without a monitoring system to track public service delivery?

FitzFord:
Question #2

Shanta, will you elaborate on how might the politicians, who may not see the benefits of the system you propose, may be convinced of the superior results that are predicted, and be persuaded that the costs as they may be imagined or real, will be presented in a beneficial
manner in their meaningful time frame?

SDevarajan:
Answer to question #1

Napodano:  Thanks for your question.  I think the limited success of performance-based budgeting has to do with many of the items you mentioned--poor policy environment, vested interests, excessive focus on planning indicators.  But there is a fourth reason that I've been concerned about.  Whenever we measure performance, we never specify the counterfactual: what would performance have been in the absence of the allocation?  Yet, unless we use the counterfactual, we create a host of problems for PBB.  For one thing, people will choose easy indicators to be measured against (effectively, indicators that would have been achieved anyway--hence the need to specify the counterfactual).  For another, performance would not be measured against what the private sector would have achieved--the point I made in the earlier post.  A third problem--which is also a problem with performance-based aid--is that there is an inherent risk in any development endeavor.  We don't know for sure whether we will achieve the result.  By making budgetary or aid allocations based on performance, we impose all the risk on the recipient, and none on the donor or budgetary authority.  Not a good way to run a railroad.  Shanta

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