Information about Asia and the Pacific Asia y el Pacífico
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Financial control in developed and developing countries: What techniques of control should a government use to stimulate or limit the expansion of the economy?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1974
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Information about Asia and the Pacific Asia y el Pacífico
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The term financial control has a wide application. It comprises the various aspects of the assessment of resources and the coordination of economic policies—including international trade, investment of the public funds, and control of public expenditures. However, the term is restricted here to the general formulation and execution of budgets and, more specifically, to control of public expenditures. On the expenditure side, financial control broadly consists of four phases: determination of aggregate expenditure, allocation of this aggregate among the competing demands, determination of the ceilings of expenditure on individual policies and services, and achievement of balance within a given service.

Financial control has evolved in three distinct stages. In the first stage the emphasis was on discipline of a rather restricted nature, dealing essentially with a narrow range of concerns relating to the expenditure ceilings approved for each department of government and the regularity and economy of this expenditure. With the increasing growth of public expenditures, the emphasis gradually shifted to management, where the concern was with selecting the best way for accomplishing a prescribed task and as an integral part, setting up units of measurement and criteria for the assessment of performance. While this aspect of management continues to be desirable, financial control, as now practiced in a number of countries, has entered a broader field, where attention is concentrated on the entire range of issues relating to the long-range goals and policies of the government and to their relationships to particular expenditure choices.

Despite variations in techniques, financial control in some of the developed and developing nations consists of a three-stage administrative process of, first, determining the objectives and the resources used to attain those objectives; second, ensuring that such resources are used to accomplish the objectives; and, third, ensuring that specific tasks are carried out effectively and efficiently. In all these three phases the same limitations apply. There is the burden of past decisions that are now irrevocable, and there is the restriction of current budgetary decisions to new expenditures. The slate is never clean, and planning, it would appear, can never be ideally comprehensive.

Incremental versus comprehensive budgeting

This situation has, during the recent past, given rise to discussion, more philosophical than practical, about the financial controls exercised through incremental budgeting and those sought through comprehensive budgeting. These two approaches are not mutually exclusive (although considered by some to be so) and should more appropriately be considered different in degree and emphasis. However, some consideration of the arguments for incrementalism, and those for the comprehensive approach, is in order for judging the relevance of financial controls. The difference between the two approaches may be stated thus: the comprehensive approach to financial management emphasizes the application of analytical criteria of effectiveness and efficiency in that it seeks a replacement of the intuitive approach to resource allocation by a deliberate examination of a wider range of alternatives. Those who favor the incremental, fragmented, and sequential approach consider the feasibility of such a comprehensive approach as doubtful in the context of a political process that is governed by compromise at each and every stage. It is their view that conflict in the political process can be minimized by reducing the specification of objectives, and by adopting the approach of movement by small steps. In essence, therefore, the difference between the two approaches is one of a choice between analytical criteria and political compromise, and between long-term planning and a process of muddling through. While the importance of political processes can hardly be overemphasized, it is apparent from recent experience that a number of countries have shown their overall preference for comprehensive planning. This approach provides the background for the following discussion.

Elements of control

The main focus of discussion here is on the experience of the developed and developing nations in varying the techniques and procedures of financial control to meet such short-term requirements as stimulating, or alternatively limiting, the expansion of the economy. The responses in such a situation are generally twofold: a change in policy to meet short-term requirements and a change in the technique of control used for the purpose. We are more concerned with the technique, although some policy premises and implications must also be taken into consideration. Also, our concern is with short-term requirements and, therefore, discussion will focus primarily on postbudget financial control to achieve the variations in expenditure necessary for meeting the diverse policy purposes.

Normally, the emphasis of financial control in the postbudget stage is on action to initiate implementation and on periodic review. The annual budgeting system makes it imperative that work be undertaken quickly to complete the various administrative formalities. Thus, the first step in financial control is to actually ensure that all necessary administrative action is taken. Having set in motion the administrative apparatus, it is necessary to ensure, through periodic review, that adequate progress is being achieved in the implementation of the programs. In terms of financial control, this involves close supervision of physical and financial progress as originally planned, analysis of variations in expenditure (as under- and overspending have their own impact on resource allocation and economic growth), and the maintenance of a regular flow of expenditure so as to avoid a rush that may take place toward the end of the fiscal year (and which is too often accepted as normal procedure). These different phases are implemented, with different techniques and accompanying degrees of emphasis, in both developed and developing countries. There is, however, some difference in the nature of the short-term issues facing these nations.

In the developed nations fiscal action is generally contemplated either to reduce inflation or to expand the economy so as to avoid a likely recession. In the developing world the issues of short-term control are inextricably linked with the long-term problems of growth. In order to stimulate growth, there is a general tendency to rely on bank credit and other related sources of financing which often contribute to inflation. An inflationary situation in turn requires that the emphasis of financial control should be on choosing appropriate projects and ensuring that adequate progress is achieved during the year. While this characteristic problem of inflationary financing continues to persist, the developing countries also experience, from time to time, a severe resource shortage that affects their growth. Such a resource squeeze may be the result of a fall in agricultural production, a fall in exports, a fall in industrial production, or a reduction in expected foreign aid. Financial control in the context of such a resource shortage is a factor that distinguishes the issues of the developing countries from those of the developed.

Despite differences in the relative settings, there are common factors—largely institutional in character—that provide an overall framework for the working of financial controls. These include the flexibility of government operation, the scope for reducing or increasing expenditures, the status of economic forecasting, planning and fiscal action, and the magnitude and direction of expenditures.

Flexibility of operation

The scale of government operations includes not only the central government, but also the operations of provincial and local governments and public enterprises. Activities at all those levels must be coordinated. Often, however, one finds the phenomenon of “fiscal perversity” wherein the policies adopted at different levels may be in conflict with one another. Such conflict reduces the flexibility of government charged with the responsibility of fiscal management. Similarly, the control of operations of public sector enterprises may give rise to questions of jurisdiction and autonomy. In addition, there may be procedural matters involving the legislatures that may reduce the flexibility of the executive. In some countries not only are the powers delegated to the executive restricted but many necessary fiscal measures may not be undertaken because the legislature’s schedules may not permit a quick passage of the required legislation.

Because of this, some compensatory devices have been evolved (such as contingency funds and emergency tax laws), but their adequacy should be periodically evaluated.

Variations in expenditure

To what extent are variations in public expenditures feasible? It is the experience of developed countries such as the United Kingdom, Germany, and the United States that attempts to increase expenditure have often been frustrated by a lack of projects capable of emergency implementation. Where specific public works were intended to provide relief, there was a lapse of six to nine months before they could be launched (and consequently an even longer period for the short-term changes to have their full effect) and often there were enormous unspent balances at the end of the fiscal year. In the developing world, where experience is far from exhaustive, relief projects undertaken in areas of scarcity have generally been unproductive; with appropriate advance planning, the resources could have been used for more profitable or beneficial ventures. Thus, important factors in ensuring that increases in expenditures have the desired effects are the availability of carefully screened projects and appropriate timing of the expenditures.

The process of bringing about reductions in expenditures is, however, rather different. Such reductions involve either slackening the rate of growth of expenditure or reducing its absolute levels—but governments usually take the former step. However, budgetary outlays rarely drop, as there is a built-in anticipation of more services to come. Indeed, as Dahl and Lindblom pointed out in Income Stabilization in a Developing Democracy (Max Milliken, ed., Yale University Press, New Haven, 1953), government expenditures generally mean that “services are performed, values are realized, administrative organizations developed, expectations expanded, clienteles formed, interest groups created, pressures mobilized, and once these are set in motion, they cannot easily be contracted.” Apart from the built-in anticipation, experience indicates that it may be a formidable task to reduce expenditures once they are increased. It is the experience of the United Kingdom (and elsewhere) that while organizing increased expenditures proved relatively easy, stopping them proved to be almost impossible politically—with the consequence that there was little option but to maintain the expenditures. To a large extent this is due to a sort of ratchet effect, where each time an expenditure is undertaken to combat recession, the probability is that outlays will be ratcheted upward, as such increases may prove rewarding to the groups of individuals or sectors participating in the process. Added to this factor is the earmarking of funds by law. For example, according to the Economic Commission for Latin America “80 per cent of public expenditure (in Latin America) is inflexible, i.e., it is ruled by permanent laws which the actual budget law is powerless to change.” While such earmarking may have been undertaken initially with a view to providing a good deal of autonomy to some of the spending agencies, it reduces the power to vary expenditures.

Apart from such procedural problems, there are expenditures that by their very nature are hard to reduce: regular or maintenance expenditures, where major reductions are generally not feasible, and those current expenditures—e.g., food subsidies and price supports—which to a major extent depend on the economic climate. Outlays that can be modified in the light of desired government influence on economic development include public works expenditures and investment outlays. Recent experience in some countries indicates that the element of relatively uncontrollable expenditures (i.e., continuing expenditures) has been on the increase. For example, in the United States, this element has gone up from 63 per cent of total expenditures in 1967 to about 75 per cent in the 1974 budget.

Forecasting

Financial control geared to short-term variations in expenditures is simply not feasible without an adequate system of forecasting which seeks to identify continuing financial burdens resulting from current policies. Economic analysis undertaken as an integral part of such forecasting indicates the likely areas of action where variations in expenditures may have the necessary effect. The availability of such forecasting facilities may determine, to a very considerable extent, the character and content of financial control.

Planning and fiscal action

Yet another general factor that must be kept in view is the requirement that changes in expenditures for short-term purposes should be made in such a manner as to conform with the long-term objectives of a plan. Without this, changes in expenditures will be indiscriminate and may distort the processes of growth. It is the experience in some developed and developing countries that, when it comes to reducing expenditures, the axe generally falls on social services or economic services while outlays on security and related general administrative services are maintained. It is therefore essential that variations in expenditure should be undertaken with the minimum hindrance to the achievement of long-term objectives.

Magnitude of expenditures

Finally, the magnitude of variation in expenditure is of the utmost importance. If the order of such variation is low, it is unlikely to have any impact on the economy and the whole effort could become a case of misdirected energy. Similarly, if increasing expenditures merely increases transfer payments, little will be accomplished if the real need is to increase capital outlays. Financial control has thus a twofold task in relation to variations in expenditure—changing the magnitude and varying the composition of expenditures. No hard and fast rules, however, can be laid down regarding the desirable magnitude, since much depends on the institutional factors and time lags involved.

Techniques of control

Within this general framework several techniques of financial control can be adopted to achieve the desired ends. The broad set of techniques and measures now in vogue are summarized in the accompanying table. Some of the problems that arise in implementing the techniques and the lessons of experience obtained during recent years may be noted briefly here.

In the nature of things these techniques cannot be achieved with push-button efficiency; on the contrary, they need careful advance planning. This is particularly so with regard to maintaining a shelf of projects and programs. The general notion that these can either be taken from a boiling pot and launched without undue delay or be reduced without seriously impinging on the objectives of growth is not true. In fact, if such a selection were to be made it is quite likely that it would lead to large amounts being spent on unproductive projects, often with disastrous consequences. As for reducing expenditures, experience is that governments, particularly in developing nations, simply resort to across-the-board cuts, which implies that all expenditures are treated equally. Such all-round percentage subtractions or additions are, however, likely to result in misdirection of resources and, as the Plowden Committee noted in 1960 in Britain, “if any increase or decrease is required in the total government expenditure, the only sensible course is to decide to treat the departments unequally.” Such differential treatment should in fact reflect the current priorities of a government. It is also important to have a selection of items or programs that are amenable to change; the selection should be based on specific criteria in order to satisfy the legislature that the choice of changes in expenditure is more than just random.

The experience of some, notably developing, countries, indicates that policy emphasis on quick-yielding projects is not always accompanied by the introduction of techniques for identifying such projects either in the stage of financial planning or in the formal budgetary process itself. Similarly, procedural difficulties are experienced both in the recruitment of personnel and also, where reductions in expenditure are sought, in holding administrative positions vacant without unduly hampering the normal administrative process. The whole process is a delicate one in which a balance must be sought between excessive action that might affect the achievement of overall objectives and too limited action that might defeat the short-term objectives. It should also be noted that the implementation of cash management budgets, which have the somewhat narrow but important function of ensuring liquidity, has led to a twofold difficulty: (a) in some cases, because of the exclusion of some functions from the budget, its effectiveness was reduced in view of its limited coverage and (b) spending agencies had to adjust their priorities within the allotted amounts (which were in some measure also affected by the extreme seasonality in the collection of revenues) which was found to be difficult in the absence of a detailed framework of priorities.

An eclectic approach

My enumeration of problems in the implementation of certain policies and related techniques is undertaken not so much to highlight the deficiencies in the processes as to emphasize the complexities of current economic management and the continuing—and ever more pressing—need for devoting greater attention to this area. It would be farfetched to suggest that universal prescriptions can be laid down for the purpose. Indeed, techniques and measures have to reflect the socioeconomic and political objectives and, in particular, the bureaucratic and organizational behavior of the country. However, an eclectic approach reflecting the essential elements of financial control would involve modernization of the budgetary process and related tools, operational cohesiveness between planning and finance agencies, development of competence in internal financial management in the spending agencies, and contingency planning (either on a comprehensive basis or with reference to certain soft spots) that would provide a margin for expansion or reduction.

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