The Basic Budgeting Problem Book

The Basic Budgeting Problem Book
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    Working Paper 147The Basic Budgeting ProblemApproaches to Resource Allocation in thePublic Sector and their Implicationsfor Pro-Poor BudgetingAdrian FozzardCentre for Aid and Public ExpenditureJuly 2001Overseas Development Institute111 Westminster Bridge RoadLondonSE1 7JDUK

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    ISBN 0 85003 527 9© Overseas Development Institute 2001All rights reserved. Readers may quote from or reproduce this paper, but as copyright holder,ODI requests due acknowledgement.

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    Contents1. Introduction52. The Basis of Resource Allocation62.1Public goods and the rationale for public intervention62.2Marginal utility and cost effectiveness92.3Allocative efficiency and cost benefit analysis122.4Citizens’ preferences and collective decision making152.5Equity, incidence and ...

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    1. IntroductionSixty years ago V. O. Key laid down a challenge for economists to resolve the ‘basic budgetingproblem’ namely, faced with limited resources, ‘On what basis shall it be decided to allocate xdollars to activity A instead of activity B?’ (Key, 1940: 1138). He went on to sugges...

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    62. The Basis of Resource AllocationThis chapter provides an overview of the guiding principles that have been proposed as the basisfor resource allocation decision making in the public sector and techniques developed to facilitatetheir application. None of these principles can provide an all-emb...

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    7market provision through consumption sharing agreements, so that club members can maximisetheir benefits by excluding non-members. As a result, the level of provision is likely to be lowerthan would be socially desirable (Buchanan, 1965). Schools and other public services in whichaccess can be r...

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    8Following this rationale, assessments of the scope for public intervention should be based on ananalysis of the prevailing demand and supply characteristics of goods and services. For Pradhanthis market analysis is the ‘principal, initial criterion in screening public expenditure allocations...

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    9activities and redistributing assets. As State financial and managerial capability increases, it mayprogress up this hierarchy of functions, so that all governments would provide pure public goods –law and order, public health, rural roads – and would accumulate and expand other functions ...

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    10brain’ (Premchand 1983: 44). Secondly, even if one accepts the notion of a unitary community,government is still left with the problem of constructing a utility function encompassing all thegoods and services that it might be called upon to provide in order to derive the marginal utilities at...

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    11do not reflect a ‘social’ utility function, reconciling the relative utility for different members ofsociety. It is merely assumed that the outcome measured by the indicator is desirable and equallydesirable to all. Furthermore, measures of cost-effectiveness focus on only one of the benefi...

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    12‘evaluate the trade-offs between alternative combinations of expenditure-outcome combinations’(1996: 97). Although Pradhan suggests that attempts can be made to establish a commondenominator using the principles of cost-benefit analysis (see Section 2.3) or by imposingvaluations for specifi...

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    13effectiveness cannot provide the first of these elements, and offer only a partial – sector orprogramme specific – solution to the second. Comprehensive solutions have been found in theconcept of allocative efficiency and the monetary valuation of costs and benefits, both of which areapplie...

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    14generated and their distribution over time. The discount rate chosen is critical in determining theviability of the project: a high rate will reduce the stream of benefits, may penalise large projectswith substantial start-up costs and will tend to penalise deferred benefits, such as those from...

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    15project. Given the wide margins of uncertainty regarding valuations, the method is most useful indistinguishing between those interventions that are clearly viable and those that are not, or inranking alternative projects with similar characteristics – such as alternative power plants, irriga...

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    16small, since the cost-share borne by the citizen will be relatively large and failure to reveal demandis likely to reduce supply. In contrast, where the number of beneficiaries is large – as is the case formany public goods – the individuals cost share is minimal and failure to reveal will ...

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    17Collective decision-makingFor Musgrave, the problem of preference revelation and aggregation is best resolved byconstitutional, voting arrangements. Where allocation decisions are subject to voting, taxpayers ‘areinduced to reveal their true preferences … [because] knowing that the outcome ...

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    18these obligations may be accepted as falling outside the freedom of individual choice that ordinarilyapplies’. Whatever the underlying rationale, the notion that the public sector should intervenecontrary to individual and collective preferences smacks of paternalism and runs counter to thepr...

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    19Where information on service costs is incomplete or poor quality, data on service usage by incomegroup allows an assessment of the extent to which the poor benefit in proportion to other incomegroups. However, cost information is needed if it is intended to compare and aggregate the impactof sp...

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    20incidence where public services are effectively club goods (see Section 2.1) or where the poor arenot given the same treatment as higher-income groups. The cost of services is an inadequate proxyfor the benefits received anyway since it fails to take into account the ability of different social...

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    21technologies. There may also be strong political motives for the preference for public investmentsin assets rather than transfers of income as a means of reducing poverty and inequality. Direct cashtransfers are likely to be unpopular amongst the higher income groups, who are required to financ...

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    22purposes of redistribution and how these resources should be distributed within society.Unfortunately, economic theory provides little guidance on these questions since there is noconsensus regarding the optimum or just distribution of income or assets (Cullis and Jones, 1998:217-223). These is...

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    233. The Process of Resource AllocationAlthough the principles and techniques outlined in Chapter 2 can provide a useful guide todecision-making, they do not provide a definitive solution to the basic budgeting problem.Resources are allocated through a decision making process involving diverse in...

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    24of public expenditure. It was, therefore, unnecessary to assess all institutional expenditures eachyear. Instead, allocations were determined on an historic basis, taking into account prior allocationsand budget execution, with attention focusing on justifications for new programmes and increas...

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    25Budgetary decision-makingWhile the traditional approach was rigorous regarding the process of resource allocation, itprovided little or no guidance regarding the basis for resource allocations decisions. Such decisionsbelonged to the political realm, where citizens’ broad preferences were exp...

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    26The rationalist approach seeks to relate policy to clearly specified goals for public intervention. Incontrast to the administrative approach, where policy is the exclusive realm of politicians,technicians are involved in the definition of policy goals through a process of problem analysis.Once...

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    27of information required to assess the relative priority of programmes and their performance. Oftensuch information was not collected on a routine basis, a problem compounded by the fact that someagencies refused to cooperate; certainly, institutions had little incentive to provide information t...

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    28development planning, which is relegated to the function of providing policy guidance. Projects areidentified ‘bottom-up’ by spending agencies. Consistency with government policy is then ensuredthrough a process of project appraisal and approval, usually managed by the planning agency(OECD,...

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    29governments’ and development agencies’ procedures through the use of logical frameworks tosupport financing decisions and monitoring and evaluation schedules. Although policy analysis isstill prominent, the use of appraisal techniques – such as cost-benefit analysis – is now largelyrest...

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    30their allocations and will pursue other policy goals as long as they do not entail a reduction in theagencies’ allocations (1974: 20). As a consequence of these risk averse bargaining strategies,agencies’ proposals reflect not just their institutional goals, but also the anticipated respons...

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    31as well’. Certainly, in contrast to the breadth of the empirical studies, attempts to develop anincremental theory have focused narrowly on the mechanics of budgeting, by attempting todemonstrate that allocations are largely determined by incremental adjustments of the budget base(for instanc...

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    32Ministry of Finance but ‘guardians’ in relation to their internal departments (see Box 6). Not eventhe integrity and stability of the budget process is sacred: as the budget stalemates of 1990, 1995and 1998 in the United States illustrate, politicians may prefer to stall the budget process ...

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    33refinement of Wildavsky’s work, Meyers (1994) has argued that budgeters can be expected to workaccording to ‘structural strategies’ which seek to establish the institutional arrangements that bestsuit their interests. In this case, the outcome of institutional reforms is determined by the...

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    34benefit a particular geographical constituency exclusively or disportionately but are financed fromgeneral taxation so that the costs are spread nationally. Since self-interested voters are likely to votefor representatives that bring them benefits at low cost, representatives will promote pork...

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    35institutions tend to centralise authority at the various stages of the budget process, reducing theopportunities for democratic decision making and overruling minority interests. They will enforcefiscal restraint and tend to generate budgets which benefit the majority, providing little scope fo...

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    36Minister of Finance enjoy no special status with regard to budgetary decision making. Collegialarrangements prevail. Resource allocations must be negotiated and agreed collectively, providingopportunities for reciprocal agreements between Ministers and favouring universal programmes,both of whi...

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    37minimum cost of providing the services it acquires. In this context, the budget maximisingbureaucrat will tend to oversupply goods and services, so as to increase their budget allocation, andwill allocate these resources so best to serve institutional and personal interests. Resources may, fore...

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    38ConclusionAs one might expect, the budget maximising bureaucrat thesis is attractive to politicians, since itjustifies their intervention in agency management, and to conservative politicians in particular,because it justifies a greater role for the market and the private sector in service prov...

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    39Since the assumption that allocational decisions will be translated into budget outcomes does notalways hold, solutions to the basic budgeting problem must demonstrate not only the basis onwhich resources are allocated between competing priorities but also how this allocation caneffectively imp...

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    40budget procedures and institutions, this fails to resolve the underlying problem: agents act againstthe principals’ interests because their interests diverge. An alternative approach seeks to address theproblem of divergent interests by providing incentives for the agent to pursue the princip...

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    41assertion. Off-budget funds, public enterprises, supplementary budgets and a variety of othercreative accounting techniques are also employed to ensure that resources escape parliamentary andhence public scrutiny, creating what has been termed ‘underground government’ (Merrifield,1994). In ...

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    42allocation outcomes can be improved through institutional reform, particularly those that improvethe transparency and credibility of the budget process. The question is, who will champion thesereforms? There are grounds for believing that politicians share a mutual interest in maintaining adisc...

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    43media has a crucial role to play in both the creation and dissemination of this information. Wherethe media are independent and take an active, critical interest in public expenditure issues, there islikely to be greater pressure on government to improve its performance and transparency. Wheret...

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    444. ConclusionAfter a search of sixty years for a comprehensive theory of budgeting that would resolve the basicbudgeting problem, it is somewhat disappointing to arrive at a conclusion that no such theory existsand it is unlikely that such a theory can ever be formulated. It is even more disapp...

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    45as audit institutions and independent statistical authorities – as guarantors of transparency and ameans of ensuring compliance in the executive.Transparency can also be improved by providing opportunities for citizens and the beneficiaries ofpublic service to voice their priorities and conce...

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    46ReferencesAblo, Emmanuel and Ritva Reinikka (1998) Do Budgets Really Matter? Evidence from PublicSpending on Education and Health in Uganda, World Bank Policy Research Paper, 1926.Alesina and Perrotti (1996) Budget Deficits and Budget Institutions, MF Working Paper 96/52,Washington D.C.Allard, ...

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    47Cowper, Jeremy and Samuels, Martin (1997) Performance Benchmarking in the Public Sector: TheUnited Kingdom Experience, OECD, Paris.Cox, D. and Jimenez, E. (1992) ‘Social Security and Private Transfers in Developing Countries: theCase of Peru’ World Bank Economic Review, 6 (1) 155-169.Crain,...

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    48expenditure, staff and patients?’ Health Policy 40 (1) 43-67Gwilliam, K. and Z. Shalizi (1999) ‘Road funds, user charges, and taxes’ World Bank ResearchObserver 14 (2) 159-186.Hansen, J. M. (1998) ‘Individuals, institutions, and public preferences over public finance’American Politica...

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    49Lindblom, Charles E. (1959) ‘The Science of Muddling Through’ Public Administration Review 19(2) 79-88.Lindblom, Charles E. (1979) ‘Still muddling, not yet through’ Public Administration Review 39,517-526.Llyod-Sherlock, Peter (2000) ‘Failing the Needy: Public Social Spending in Latin...

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    50OECD (1992) Development Assistance Manual. DAC Principles for Effective Aid, Paris.Parry, Richard, Christopher Hood and Oliver James (1997) ‘Reinventing the Treasury: EconomicRationalism or the Economists’ Fallacy of Control’, Public Administration, 75, Autumn, pp.395-415Patashnik, E. M (...

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    51Schick, Alan (1988) ‘An Inquiry into the Possibility of a Budgetary Theory’ pp. 59-69 in IreneRubin (Ed) New Directions in Budget Theory, State University of New York, Albany.Schick, Alan (1998) A Contemporary Approach to Public Expenditure Management, World BankInstitute.Schultz, T. Paul (...

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    52studies 15 (4):119-135,Williamson, Oliver (1998) ‘Transaction Cost Economics: How it works, where it is headed’, DeEconomist, 146 (1) 23-58.World Bank (1990) World Development Report: Poverty, Oxford University Press, New York.World Bank (1993) World Development Report: Investing in Health,...