Performance-Based Budgeting In South-Eastern Europe

ARTICLES

Central European Journal of Public Policy – Vol. 8 – № 1 – June 2014

Performance-Based Budgeting In South-Eastern Europe: A Legal And Economic Perspective Aleksandra Maksimovska-Veljanovski and Aleksandar Stojkov Law Faculty, Ss. Cyril and Methodius University in Skopje (Macedonia)

Abstract: During the 2008–2013 period, a wave of fresh ideas for introducing performance-based budgeting (PBB) occurred in the region of South-Eastern Europe. Based on a theoretical framework and empirical assessment using novel methodology, this study examines the preconditions and assesses the capacities for introducing PBB in South-Eastern European (SEE) countries. Generally, SEE countries have demonstrated moderate progress in implementing elements of performance budgeting. All of them follow a similar approach to embarking on these reforms, but with a different policy attention to certain aspects. On the other hand, SEE countries with limited progress demonstrate strong political commitment to kick-start this area by investing in the development of budget administration skills. The study conveys a balanced mix of political, legal, administrative and economic analysis of the core elements of PBB. The novel idea of introducing a simpler model of PBB in SEE is examined. To the best of our knowledge, this is the first systematic attempt to provide a comprehensive analysis of the institutional arrangements and prospects for adopting PBB in the region of South-Eastern Europe. Keywords: Performance-based budgeting, budget reforms, performance measurement, South-Eastern Europe ALEKSANDRA MAKSIMOVSKA – VELJANOVSKI – Professor of Financial Law, Faculty of Law, Ss. Cyril and Methodius University in Skopje (Macedonia) • [email protected] ALEKSANDAR STOJKOV – Professor of Economics, Faculty of Law, Ss. Cyril and Methodius University in Skopje (Macedonia) • [email protected]

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Central European Journal of Public Policy Vol. 8 – № 1 – July 2014 – pp 50–77 ISSN 1802-4866 © 2014 Aleksandra Maksimovska-Veljanovski, Aleksandar Stojkov Licensed under Creative Commons Attribution 3.0

– Maksimovska-Veljanovski, Stojkov • Performance-Based Budgeting…

INTRODUCTION Performance-based budgeting (hereinafter: PBB) has gained significant popularity among OECD countries over the past two decades, although some countries have recently admitted that they had fuelled overly optimistic expectations about its potential for improvement of the efficiency and effectiveness of public expenditure. Nevertheless, many South-Eastern European (hereinafter: SEE) countries are in the initial stages of its implementation and are currently placing strong faith in PBB. Despite the official enthusiasm in this region, the academic assessments of the pros and cons of PBB-related reforms are very scarce. We argue that the aftermath of the recent global economic meltdown is the proper time to revisit the traditional budgeting model and reconsider the net benefits of introducing models of PBB in these countries. Until now, no SEE country can present itself as successfully embracing PBB. Yet there appears to be a strong political will which has already been translated into amendments in relevant budget laws for introducing PBB. Simultaneously, there are many sectoral pilot projects for implementing the performance orientation in these countries in the areas of education, health, defence, etc. Therefore, performance budgeting is already on the political agenda in South-Eastern Europe. The main challenge now is to find an appropriate model for its successful implementation and to be fully aware of the mixed experiences in the OECD countries. Our main explicit assumption is that performance-based budgeting has the potential to produce credible future budget commitments, enable more efficient expenditure prioritization and improve aggregate fiscal discipline in the SEE countries. The specific research objectives of this study are: (1) to assess the key features and challenges of performance budgeting; (2) to explore the factors determining the success of introducing performance budgeting systems in SEE countries in foreseeable future, and (3) to draw relevant conclusions for forthcoming PBB-related reforms. The geographical context of investigation is confined to five countries: Albania, Bulgaria, Croatia, Macedonia, and Serbia. This sample constitutes an interesting mix of countries, as they are at a similar level of economic development, but with a different progress in the Euro51

ARTICLES – Maksimovska-Veljanovski, Stojkov • Performance-Based Budgeting…


pean Union (hereinafter: EU) integration effort. This study fills an important gap in the literature, since there are only a few articles published in peer-reviewed journals, mainly with a national focus. To the best of our knowledge, this is the first systematic attempt to provide a comprehensive analysis of the institutional arrangements and prospects for adopting PBB in the region of South-Eastern Europe. The remainder of the paper is organized as follows. The next section elaborates the evolution of budgeting systems before the emergence of performance-based budgeting. The third section highlights the key features and challenges of introducing PBB and provides a critical review of the relevant theoretical and empirical literature. The state of performance budgeting in South-Eastern Europe is elaborated in the fourth section. The methodology for quantifying countries’ progress in implementing elements of performance budgeting is elaborated in the fifth section. The main findings are conveyed in the final section.

its outcome orientation, it has come to be known as result-oriented and later, performance-based budgeting. The renewed enthusiasm for PBB was associated with the New Public Management reforms aiming to improve public sector performance and achieve fiscal sustainability. The reforms of the budgetary systems were justified on economic grounds, but in the same time, highly dependent on the political will. Schick (2002) accentuates two recent developments that are shaping the legislative work on budgets. One is the drive to discipline public finance by constraining fiscal aggregates (Crain and O’Roark, 2004; European Commission, 2007), whereas the other is the effort to enlarge the legislature’s role in revenue and spending policy. One scenario is for the legislature to reinforce fiscal discipline by taking responsibility for the budget’s totals. Another scenario is for the legislature to undermine discipline by attacking the budget submitted by the government with legislative amendments that trim revenues or boost expenditures. PBB recognizes some of these remedies, taking responsibility and making budget and administration more accountable for results of the financed project.

PRECURSOR MODELS OF PERFORMANCE-BASED BUDGETING The first wave of performance budgeting – as we know it nowadays – occurred in the United States during the 1950s under the guidance of the President’s Bureau of the Budget (Jones and McCaffery, 2010). The evolution of budgeting witnessed several traditional methods of budgeting: (1) a planning, programming and budgeting system; (2) zero-base budgeting, and (3) sunset legislation (see Broadnax, 1977; Jantz and Veit, 2010). Broadly speaking, these systems and methods were adjusted to the one-year budgeting cycle, implying that their effects could not be viewed in the medium to longer term. It was somehow expected that the system of planning, programming and budgeting would be subject to further study and revision in order to involve more analytical techniques for efficiency improvement. In any case, the return to traditional budget planning in the 21st century was not expected. From a traditional perspective, organizations start building up their long-term plans and break those plans into annual budgets that are formed as forecasts. At the end of the year, the budget figures are compared with actual outcomes and a simple budget variance analysis is calculated. This analysis lacks decent sophistication in terms of adjusting similar budget items for the forthcoming periods by altering the expenditure estimates. The calculated deviation is then used for revising monetary amounts for the next planning and budgeting cycle, and also, for very simple departmental performance tracking. The new approach to budget analysis and utilization is many steps ahead of the traditional methods. Based on 52

LITERATURE REVIEW: PROS AND CONS OF PERFORMANCE-BASED BUDGETING There is an extensive literature examining PBB, which we classify into the traditional and the contemporary strand. The border line is the late 1980s, which brought the first disappointments with precursor budget reforms. In order to limit the critical review of the relevant literature, we focus only on the studies published in the past two decades. A blossoming strand of research reflects the continuous need for improvement of public sector performance, which often embraces reforms of budgeting systems. This argument is supported by a study by Kelly and Rivenbark (2003) arguing that citizens require public sector reforms in times of both economic prosperity and hardship. When the economic conditions are favourable, government officials aim to introduce far-reaching management reforms. In times of crises and economic hardship, individuals and firms also expect the public sector to be more active in guiding the country. In practice, PBB has been among the most prominent reforms on the budget agenda in many developed and developing countries in the last decade (Schick, 2007; Marti, 2013). What is performance-based budgeting in a nutshell? Performance budgeting focuses on three elements: (1) the final outcome; (2) the strategy (different 53



ways to achieve the final outcome), and (3) the activity and outputs, or what is actually done to achieve the final outcome (e.g., Segal and Summers, 2002; Schick, 2007; Ilyashenko, 2012). The overall goal of performance budgeting is to improve the effectiveness and efficiency of public sector operations. It also aims to achieve three more specific objectives: productive (or technical) efficiency; allocative efficiency, and aggregate fiscal discipline (e.g., Robinson and Brumby, 2010). Productive efficiency is achieved when the desired outcome is accomplished with the least input possible. In contrast, allocative efficiency indicates that budgets are attributed to the programs according to their performance and/or highest marginal output. Both productive and allocative efficiency should support the third aim – the aggregate fiscal discipline (Musgrave and Musgrave, 1988). If the outcomes can be achieved by fewer inputs, this should have an effect on fiscal performance, either at the sectoral or aggregate level. Measurement of results appears to be the most significant challenge for PBB. The final goals are not consistent with the profit-maximizing behaviour of the private sector. The prices of output in the public sector are difficult to measure because many goods and services are not offered on the market. This is why the efforts of the public sector are commonly measured by the inputs. However, this procedure may provide incentives to distort the true input in the sense that bureaucrats tend to maximize the required inputs. This makes it hard to measure success or failure through indicators. For instance, in many PBB systems it is common to introduce result-oriented salaries for public sector employees. Performance needs to be linked to rewards or sanctions. The measurability of actions becomes important if the salary is dependent on the performance of this action.

2002; Schick, 2002, 2007). The PBB process is a tool that program administrators can use to achieve more cost-efficient and effective budgeting. Once the long-term plans are accomplished, the traditional way to assess the effectiveness of the entire project would be to detect the gap between the budgeted amounts and actual money spent. Third, the PBB vocabulary is based on statements of missions, goals and objectives to explain why the money is being spent. This budget system aims to allocate resources to achieve specific objectives based on program goals and measured results. The key positive aspect of PBB, which differentiates it from the other budgeting models, is the expected result of public spending. In this system, the entire planning and budgeting framework is result-oriented, as the objectives and activities form the foundation of the overall evaluation (Lorenz, 2012). The rational budget manager in the PBB environment uses all relevant information and facts to make decisions. The common motivation for PBB is to provide information about the performance of projects in order to make a decision for efficient allocation of financial resources. Fourth, an advantage of the PBB system is the measurement of the degree to which the predefined outcomes have been achieved by the program or project manager. Fifth, measurement is a key tool for performance budgeting. Therefore, PBB ought to be conceptualized as a goal, or a set of goals, to which budget expenditure is allocated. From these goals, specific objectives are delineated and funds are then subdivided among them (Harrison, 2003). Contemporary literature injects new optimism into the PBB perspective, focusing on several important questions: (1) what is the most important ingredient for implementing a PBB system? and (2) is PBB a sustainable budgetary mechanism in future? Firstly, a growing consensus among the academic community emerges on the key ingredients for a successful PBB implementation: strong institutions, focus on a narrow set of realistic goals, a set of measurement tools and policy commitment (OECD, 2007; Lorenz, 2012; Olden et al. 2012). Secondly, there are both pessimistic and optimistic forecasts about the future of performance budgeting. However, an overwhelming part of the academic community argue that the current wave of performance budgeting will persist and develop for a longer period of time. The optimists’ camp puts much emphasis on the “limitless” possibilities of information technology, which has never been as sophisticated and powerful as presently (Schick, 2003). Nevertheless, the implementation problems are numerous and often complex. In the context of SEE transition countries, academic literature is very scarce and it mainly exists in the form of working papers rather than articles in refereed journals (e.g., Tandberg and Pavesic-Skerlep, 2009; Olden et al.

The Key Advantages of Performance-Based Budgeting

Although studies differ in some conclusions, the relevant academic literature identifies certain advantages of PBB. First, performance budgeting is regarded as a system that connects politicians (the decision makers) and voters in the formulation of budget priorities (Lorenz, 2012). For example‚ex ante set outcomes allow elected officials to recognize the priorities of programs for which they are made accountable by the voters. If the voters’ preferences for the provision of services change, then the performance information makes it easier for the official to revise programs and take an action. Second, performance-based budgeting is based on the relationship between program funding levels and expected results (Bouckaert and Peters, 54

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2012). Some studies analyze only certain aspects of PBB (Diamond, 2003, 2006; Hawkesworth et al. 2009; Kasek and Webber, 2009; Džinic, 2011). The identified gap in the academic literature therefore justifies this study.

formance is the so-called yardstick comparison. Its advantage is that it evens out those deviations that are not due to the employees’ efforts or shirking, but rather due to external factors beyond the agent’s control (Lorenz, 2012). Since the external factors always play a role, the latter approach must not be downplayed. The third set of problems is associated with the hesitant and partial introduction of PBB in parallel to the traditional budgeting system. Andrews and Hill (2003) emphasize that performance budgeting should actually replace the old system. They identify the strict replacement of the old system as a decisive factor for the success or failure of the new one. This assertion is also supported by the results of a GAO (1993) survey in which state managers of the leading performance budgeting states in the United States claimed that the new reform efforts were not compatible with the traditional budgeting and accounting systems. However, in the case of SEE countries, it is useful to rely on several forms of displaying budget figures and cash budgets should not be voided. The fourth set of obstacles stems from the inability to separate accountability between different budget executors. OECD (2007) reports negative effects of separating accountability between agencies and ministries in New Zealand. More specifically, the agency managers were accountable for the outputs, whereas ministers for the outcomes. The cross-country study accentuates that holding agency managers accountable for results and measuring their performance against objectives does not seem to be applicable without considering the outcomes. Ministers were evaluated by the achievement of outcomes, but interdependences between the different areas they monitored were ignored. Hence, ministers had to rely on a well-functioning information system run by their employees to react to performance problems, because their workload interfered with their performance as ministers. The fifth set of difficulties is associated with ownership of the budgetary reforms as demonstrated by the limited acceptance and support by government employees (Broom and McGuire, 1995; OECD, 2007). Government unit managers are not integrated enough in the process and perceive it as an obligation from the top they now have to carry on their shoulders. The consequence is low identification with the new procedures and an even less motivation among lower-ranking officials. Moreover, in-depth understanding of the entire system and its effects on day-to-day life is missing, when one does not know what their system looks like from the bottom, as Hughes (2008) critically assesses. These reforms affect the budget personnel most, because it perceives the increase in paperwork as an unnecessary additional task. A case in point is the Slovenian experience with introducing PBB as a ‘big bang’ approach. Some elements of the new budgeting system have not been well accepted in the line

Implementation Problems and Disappointments

The problems in introducing the pure PBB model can arise due to measurement problems, insufficient institutional capacity or lack of government commitment. Their importance has been well captured in a brave statement by Schick (2003, p. 83) claiming that “efforts to budget on the basis of performance almost always fail.” We find this debatable, given the mixed experiences of OECD members (OECD, 2007). The first set of problems is related to the measurement of outputs. The challenge seems to be to grasp the big picture through the right balance between too many indicators and just a few aggregate indicators. The studies by Aristovnik and Seljak (2010) and Aristovnik (2013) emphasize that these indicators should be measurable. Other authors have been rather critical of the potential pitfalls of “measurement obsession”. Bouckaert and Peters (2002) highlight the illusion of having everything under control with a sophisticated measurement system. They argue that the measurement should involve only politically important actions, rather than the lower level ones. Only the ‘big’ goals are the ones that are communicated to the public, as they have an impact on citizen satisfaction and trust. An interesting case in point is the experience of the Netherlands with the introduction of an “accountable budgeting” reform in 2013, which was essentially a step back and a disappointment from the ambitious PBB model. In practice this implied that about 50% of all performance indicators disappeared from the budget documents in order to meet a more realistic set of expectations. Denmark, Sweden, Australia and Canada have also reviewed their approaches in order to improve the use of performance information in budgeting (OECD, 2007). The second obstacle is the motivation of government employees. Their activities are expected to be evaluated and correspondingly remunerated. In order to do that, standards for measuring individual performance are needed (e.g., Milgrom and Roberts, 1992). One approach to employee evaluation is related to a fixed benchmark, so that the principals set absolute output values which shall be achieved by the employees. The main disadvantage of absolute output values is that employees, once they achieve the critical value, are not motivated to exert more effort (Lizzeri et al. 2002). Nevertheless, we stress that this measurement method is commonly used in the private sector for achieving better performance each consecutive year. Another approach to evaluating per56

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ministries, especially those that saw this initiative as a top-down exercise. This is also related with an excessive centralization of PBB implementation. OECD (2007) warns against such an approach which results in more rules and laws to comply with and not in a comprehensive and motivated assimilation of new elements and new procedures. On the other side, when the pressure from the top or the legislature is too weak, each unit develops its own system. The risk is that this will result in a combination of very diverse approaches and a lack of comparability. Thus, the trade-off between uniformity and flexibility is a balancing act influenced by the country’s political system. Last but not least, the political culture may not always be PBB-conducive. In many countries it has been very difficult to bring performance information to the attention of politicians. Even so, they either show insufficient interest in setting clear and realistic objectives or complain about too much information. This seems to be the case with the SEE transition countries.

Some studies do make an attempt to quantify and contrast the progress in different fiscal aspects. For instance, Olden et al. (2012) produce quantitative assessments in the range from A to F, in which: A is very strong (average rating of 2); B is strong (average rating of 1.5–2); C is moderately strong (1–1.5); D is moderately weak (0.5–1); E is weak (0–0.5); and F is very weak (0). Individual country scores are then compared against the average for the SEE countries (see Table 1). The ratings for each question are also averaged to produce an overall score of the strength of each of the ten institutions.

PERFORMANCE-BASED BUDGETING IN SOUTH-EASTERN EUROPE We start with a very selective investigation of the state of budgeting and key PBB indicators. Afterwards, we apply a novel methodology and assess the countries’ orientation towards performance budgeting. The methodological section conveys a balanced mix of legal, economic, administrative and political aspects of PBB. Also we examine the idea of introducing a simpler PBB model, which is a novel contribution of this study.

The State of Budgeting in South-Eastern Europe

The enactment of modern public finance laws and the fiscal consolidation in the early transition period have been widely considered as ‘first generation’ budget reforms in South-Eastern Europe. Although the progress across the region varied markedly, most SEE transition countries in the late 1990s or the beginning of the 2000s introduced medium-term expenditure frameworks (hereinafter: MTEF) and elements of performance-based budgeting as ‘second generation’ budget reforms (Kąsek and Webber, 2009; World Bank, 2010; Darvas and Kostyleva, 2011; Maksimovska, 2013). In this context, the success in implementing the PBB reforms cannot be assessed without reference to the state of budgeting in these countries. The following overview is only confined to budgeting at the central level. The relevant literature mainly produces descriptive assessment of the quality of recent budgetary reforms and the degree of institutional progress. 58

Table 1 Summary of Institutional Evaluation Aspects of the budgetary reforms

SEE average

ALB

BG CRO

MK

MOL

ROM

SER

A. Understanding the Fiscal Challenge

C

C

C

C

C

D

C

D

1. Fiscal reporting

C

B

C

B

C

C

C

C

2. Macro-fiscal forecasting

C

C

C

C

D

C

B

C

3. Fiscal risk management

D

D

C

D

C

D

C

D

B. Developing a consolidation C plan

C

C

B

D

C

C

C

4. Medium-term fiscal objectives

C

C

B

C

C

C

B

B

5. Medium-term budget framework

C

B

B

B

C

B

B

C

6. Independent fiscal agency

E

F

F

C

F

F

C

B

7. Performance orientation

C

B

B

A

C

C

C

E

C. Implementing the Strategy C

D

C

C

C

C

B

D

8. Top-down budgeting

C

B

A

C

B

B

C

C

9. Parliamentary approval

D

D

C

D

B

D

A

D

10. Budget execution

C

C

C

C

C

B

C

C

Overall score

C

C

C

C

C

C

C

C

Notes: [1] ALB = Albania, BG = Bulgaria, CRO = Croatia, MK = Macedonia, MOL = Moldova, ROM = Romania, and SER = Serbia. [2] A = very strong (average rating of 2); B = strong (average rating of 1.5–2); C = moderately strong (1–1.5); D = moderately weak (0.5–1); E = weak (0–0.5); and F = very weak (0). Source: Olden et al. (2012).

The methodology adopted by the noted study examines ten aspects of the budgetary reforms. In overall terms, all SEE countries rank at equal foot59



ing. We detect an important deficiency in their study, because they attach equal weights to each aspect so that the aggregate pattern and their final assessment obscure substantial sectoral heterogeneity. For example, having an independent fiscal agency is not equally important as having the capacity for fiscal risk management in terms of assessing the overall quality of budgetary systems. Another argument is that several SEE countries (but also EU member states, such as Croatia and Bulgaria), have much higher scores than the other SEE countries on a majority of well-known international comparisons relevant for the budgetary area (Open Budget Survey, World Bank Governance Indicators, etc.). The arbitrariness in summarizing the different budget indicators on equal footing merits another investigation in its own right. Due to the different objective of our study, we produce an in-depth assessment based on different methodology, solely focused on performance budgeting aspects (section 5).

PBB introduction should be gradual. A complete and immediate PBB reform would be very costly for the emerging and transition economies (Diamond, 2006). In previous work, Diamond (2002; 2003) recommended implementation of a three-stage budgeting reform: (1) providing public managers more flexibility in the access to and use of the budget; (2) enabling greater certainty regarding the availability of funds through MTEF, and (3) putting higher pressure on budget executors to focus on improving program performance in addition to micro controls. This was expected to be done during the late 2000s. Unfortunately, the financial crisis reshuffled the priorities in the fiscal area and postponed the much needed reforms. Even the gradual implementation of reforms may occur at different speeds. For example, due to the drastic political changes in Serbia in the past decade, the majority of financial reforms were implemented more rapidly. In Macedonia, the budgetary reforms were implemented systematically for 13 years, under the guidance of the international financial institutions, primarily the International Monetary Fund and the World Bank. PBB is more likely to succeed, if introduced partially. Due to numerous implementation difficulties in the past five years, most SEE countries have resorted to introduction of partial (sectoral or case-mix) performance-based budgeting systems. The application of PBB on a government-wide basis has been seen as a very ambitious undertaking, conditional upon the success of the sectoral efforts. Most SEE countries have introduced some performance dimension into their budget processes, but only Croatia has in place the institutional infrastructure, which is needed to integrate performance information into budget decisions (Kraan et al. 2006). If the PBB strategy is properly implemented, it will significantly improve the aggregate fiscal discipline and allocative efficiency of public finance in SEE. It is also expected that this reform will increase the trust in the capacity of the public sector (Bouckaert, 2012). This is even more relevant in times when governments are struggling with deteriorating fiscal positions and increased debt levels (Karkatsoulis, 2010).The expectation is also in line with the theoretical framework and the existing empirical studies and policy documents for the region of South-Eastern Europe (e.g., Kąsek and Webber, 2009).

Considerations and Expectations of Introducing (Simplified) Performance Budgeting in South-Eastern Europe

Although SEE transition countries have admired the budgetary innovations in the OECD countries, PBB initiatives have traditionally been treated as ephemeral reforms (an important exception is Croatia, which has been considered a regional leader). Introducing even a simple PBB budgeting model in the SEE transition economies should take more than a technocratic budget reform. It ought to be a component of a wider reform process in which successful implementation leads to positive changes in the public management culture. Given the pronounced political will in the region, we outline several steps for strategic implementation of the PBB model in these countries. The SEE region should aim to implement a simplified PBB model. To the best of our knowledge, the idea of a simplified PBB model for SEE is not explored yet in the existing body of empirical literature. Given the recent budget reforms in the advanced countries, it is clear that SEE can cope only with a simplified PBB model. Its simplicity should rest on a narrow set of performance indicators; cash-based or modified cash-based accounting frameworks; better-trained budget administrators; improved tools for motivation of government employees and simplified mechanisms for performance measurement. More precisely, the simplified PBB model must bridge the institutional capacity weaknesses and the strong political determination to improve budgeting outcomes. PBB reforms will be effective, if several preconditions are met: (1) strengthening the internal management control systems; (2) supporting internal audits in line with international standards, and (3) increasing reliance on modern information technologies. 60

Limiting Factors and Failures in the Transition Countries

The use of PBB in transitional countries can be simply wishful thinking, if the limiting factors are ignored. The scarce academic work in this field recognizes several limiting factors in the Central and Eastern European (CEE) region (Nemec, 2010), whereas none of the recent academic studies focuses on South61



Eastern Europe. Yet there are a number of limiting factors that are common to both regions. It is too early to discuss failures of PBB-related reforms in SEE, simply because the process is in the initial stage. The following transition-specific features may impede successful introduction of PBB-related reforms and lead to failures: • the political rhetoric is often disconnected from the transition countries’ reality; • democratic institutions and norms are not fully developed and one can still trace socialist legacies; • lack of sense of individual responsibility, paternalism and fiscal evasion (Nemec, 2010); • the rule of law needs significant improvement; • several countries in the region suffer from extreme territorial administrative fragmentation; • the private sector is not ready to compete and co-operate as envisaged by the public-sector reforms, and • public managers and budget administrators need even basic education and training in budgeting.

weights. We strongly believe that this is a sounder methodology than attaching equal individual weight to each indicator. Finally, we aggregate the assessments for each aspect and quantify the present progress in introducing performance budgeting in a particular SEE transition country. We conceptualize the performance budget orientation by quantifying the progress in exploiting performance measures and other performance information in funding decisions. In particular, we focus on the following aspects of performance budgeting: • legal basis for effective performance budgeting (PBB-related provisions in budget laws; programmatic budget structure; and legal obligation to performance orientation of the reporting framework); • financial elements (quality of accounting system, quality of internal audit and presence of medium-term expenditure framework); • performance-oriented human resource management (quality of budget administration; quality of collaboration between Ministry of Finance and line ministries; training in PBB; mechanisms towards motivation of executives for efficiency and performance), and • contextual factors (reform-conducive political environment; political will for PBB-oriented reforms and performance-based external audit).

Additionally, there is an initial pessimism stemming from the failures of PBB reforms in the advanced transition countries [e.g., the Czech Republic, Slovakia and Lithuania (Nemec, 2010), and Slovenia (Aristovnik, 2013)]. Most CEE countries already implemented PBB pilot projects in education and health, accompanied with accrual medium-term programs and performance budgeting at the national level. Disappointingly, some CEE countries are slowly moving away from PBB. Therefore, the SEE countries must consider all failures that occurred among the other transition countries.

METHODOLOGY FOR MEASURING THE CAPACITY FOR PERFORMANCE BUDGETING IN SOUTH EASTERN EUROPE We make an important departure from the precursor studies by Tandberg and Pavesic-Skerlep (2009) and Olden et al. (2012) by examining performance orientation of the budgeting system in SEE in a more systematic and analytical manner. This entails a reassessment of the importance of selected budget indicators that constitute the core of performance budgeting. In particular, we include a wider set of relevant aspects of the PBB reform as part of the crosscountry study. Then, we assess the relative importance of each aspect for having an effective performance budgeting system in place, and assign individual 62

Our approach amalgamates the political, legal, administrative and economic perspectives in assessing the performance budgeting practice in the SEE countries.

Legal Basis for Effective Performance Budgeting

Stipulating provisions on performance-based budgeting in national laws is often interpreted as a sign of strong commitment to PBB-related reforms (e.g., Bourdeaux, 2008; Lu et al. 2009). Yet none of the selected SEE countries has clearly outlined legal provisions for PBB as a central pillar of their budgeting systems. The selected SEE countries follow different approaches to introducing performance budgeting in their national law. Yet all of them are in the initial stage of drafting a PBB legislative proposal. The budget law in Albania only refers to program policy objectives and program policy goals, without further elaboration in the procedural provisions (Art. 3 of the Law on Management of Budgetary System). In Serbia, Art. 28 of the Budget System Law states that “detailed part of the budget may be presented according to the program classification presenting the goals, expected results, activities and funds necessary for the realization of the stated goals.” 63



Some countries prepare the program budget plans and implementation reports based on PBB instructions and guidelines given by the Ministry of Finance, which are not stipulated in the organic budget law (e.g., Bulgaria). This can be considered as the first step to adopt a legal basis for PBB. Other countries include PBB-related provisions in the budget law, although in rather general terms (Art. 30 of the Budget Act of Croatia). Such practice can be interpreted as a concrete step in adopting a more developed legal architecture of the PBB model. The third approach sets the legal basis for performance budgeting only on sectoral basis by adopting pilot projects through selected line ministries [e.g., Ministry of Health in the Republic of Macedonia; Ministry of Defence of the Republic of Serbia (McNab, 2011)]. In some countries (e.g., Macedonia), clear legal provisions exist for performance audit as a preparatory stage for the legal framework supporting PBB. All SEE countries have adopted a programmatic budget structure as part of the previous generation of budgetary reforms. In particular, the program budget reform in Bulgaria was initiated in 2002 for several line ministries and completed on a government-wide scale with the 2008 budget. Yet it is presented along with the traditional line-item budgeting format and performance. The transition from line-item budgeting to program budgeting in Croatia started with the 2005 budget. Albania, Bulgaria, and Croatia use programs as the legal basis for expenditure appropriations, while the other SEE countries only classify expenditure by programs in their budget documentation (Olden et al. 2012). We perceive legal obligations for performance-oriented reporting as an equally important element as the programmatic budget structure. Surprisingly, there are stark differences between the selected countries, in the sense that Croatia and Macedonia have legal provisions for reporting about budgeting outcomes, whereas Albania has not adopted such provisions yet. Serbia has also been trying to build on this experience through pilot projects by selected line ministries.

accounting systems in selected SEE countries may therefore hinder PBB-oriented reforms. Ultimately, without a sound budget accounting framework, policy decisions are ill-informed and the result chains are unclear (Tandberg and Pavesic-Skerlep, 2009). The state of the budget accounting systems in SEE is as follows. The link between accounting and budgeting in Croatia was very weak until 2002. The financial statements of the budget users were not properly used and the government accumulated sizeable payment arrears to the private sector. The year 2002 marks an important milestone with the introduction of modified accrual government accounting. The budget accounting systems in Serbia and Macedonia are still on a cash flow basis, with the exception of certain independent agencies. Budget beneficiaries can keep modified accrual accounting records for internal reporting purposes only. The accounting law in Serbia is not yet amended in line with international accounting standards. Albania has a strong political will and ambitious pilot projects for improving the accounting system and internal financial control, but its reforms are in the initial stage. In Bulgaria, it is possible to consolidate the financial reports on an accrual basis in order to ensure availability of financial information (Hawkesworth et al. 2009). Internal audit. Since measurement tools are at the core of the PBB structure, the quality of internal audit is also an essential precondition. Generally, the SEE region still needs stronger enforcement of internal audit, even though there has been varying progress. In Bulgaria, the internal audit reforms are well designed and advanced. In Serbia, since autumn 2008 there has been modest but visible reform progress in terms of upgrading the capacity for public internal financial control (PIFC) (SIGMA, 2009). In Macedonia, the internal audit framework is defined by the Law on Public Internal Financial Control adopted in 2009. The number of internal auditors has increased 2.5 times in the past five years and there has also been a large-scale training programme. Public internal financial control in Albania is still not fully based on the internationally recognised PIFC standards. Croatia puts much emphasis on training internal auditors and upgrading the capacity for public internal financial control. Presence of a medium-term expenditure framework. In terms of the medium-term focus, all SEE countries adopt a three-year MTEF. In most cases, the framework works on a rolling basis so that an additional year is added each year at the end of the period covered by the previous projection. However, budget projections are not always realistic, and may not provide a sufficient guarantee for the general public and investors that adequate political commitment and appropriate compliance mechanisms are in place to achieve the targets.

Financial Elements

Quality of the accounting system. The PBB doctrine favours the accrual accounting system as an important precondition (e.g., Marti, 2013). Given the weaknesses in the accounting systems of certain countries, some authors suggest that a modified accrual or a strongly developed cash-based accounting system is more relevant, especially when practising the initial stages of development of PBB (Diamond, 2002). The difficulties with the existing cash-based 64

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Performance-Oriented Human Resource Management

sions. The incentives for adopting and implementing PBB would then more resemble the managerial freedom in the corporate sector. With these mechanisms in place, improved cost effectiveness is a more likely outcome. Within the sample of countries under investigation, Croatia is well advanced in designing tools for motivating its budget executives (Kessler, 2009). In Macedonia the motivation tools are only introduced at sectoral level through financial schemes in the areas of health and education. In Serbia, as of 2011, performance assessment was factored into the remuneration package and career advancement (Džinic, 2011).

The success of implementing performance budgeting is very much dependent on complementary reforms in public financial management and human resource management. The latter encompasses (at least): the quality of the budget administration and of collaboration between the Ministry of Finance and line ministries; training of budget executives in PBB, and mechanisms for motivation of executives for efficiency and performance. Quality of the budget administration and of collaboration between the Ministry of Finance and line ministries. A full performance framework has been developed in Albania, built upon an integrated planning and budgeting system, but serious management problems persist (Pollo, 2008). In turn, the budget administration of Serbia has also confronted serious difficulties, mainly in the area of adopting new systematic solutions for reorganization. Macedonian budget administration has been reorganized with the previous public financial management and administrative reform. Yet a high employee turnover is a serious obstacle for preserving the institutional memory for PBB-related reforms. Croatian budget administration is perceived as the most qualified for PBB, mainly because of a new managerial structure in the public administration was adopted in conformity with EU accession requirements. The quality of collaboration between the line ministries and the Ministry of Finance is seen as a very important chain in the PBB system, and therefore an essential indicator for this study. However, there is mounting anecdotal evidence of missing collaboration between the MoF and line ministries in all SEE countries. There are at least two explanations: the hegemony of ministers of finance -prominent ruling party politicians that heavily influence funding decisions − and the exaggerated funding requests by the line ministries. Training of budget executives in PBB. Extensive training and consultations are also expected to hel p budget executives better understand the benefits of PBB and apply its techniques. The progress across the SEE region, however, varies markedly. Albania, Bulgaria, Croatia and Macedonia have had a similar scope of PBB-related trainings mainly supported by international donors during the past few years. Only recently there has been a significant progress on this front in Serbia. While these activities may support the human resources behind the PBB processes, efforts must be made to strengthen the countries’ ownership of these advanced financial management reforms. Mechanisms for motivation of executives for efficiency and performance. Besides adequate arrangements for accounting, reporting, internal control and internal audit, additional mechanisms for motivation of executive officials should be made in order to make them effectively accountable for their deci66

Contextual Factors

The inclusion of contextual factors follows the argument that budgeting is strongly influenced by the political, institutional and social environment. Reform-conducive political environment. All selected SEE countries underwent significant political and economic transformations in the past two decades (the transition period). Furthermore, they have been faced with numerous legal and economic reforms on their EU integration path. For this reason, the democratic consolidation of these countries and the prospects of EU accession created a reform-conducive political environment. Our assessment in this area follows the most recent transition indicators published by the European Bank for Reconstruction and Development. Political will for PBB-oriented reforms. Our assessment of the political will for introducing PBB is based on a careful examination of the most recent fiscal strategy documents. In general, there is a political will for PBB in the region, although in some countries it is only present in the official rhetoric. In many SEE countries, PBB-related efforts occur on an ad hoc basis; the action plans are unrealistic and sometimes focused solely on the short term. A better alternative is to design a more realistic medium-term strategy (for up to five years) that will connect the formally articulated reform objectives and today’s reform expectations. The political will for implementing PBB, at least through declarative statements, is strongly articulated in Serbia. A project funded by the United States Agency for International Development brought together the General Secretariat, the International Monetary Fund, two EU Projects, the Swedish International Development Cooperation Agency Project, and a UK Government programme to formulate unified recommendations on how to move toward performance-based budgeting. In Macedonia, there is partial political will because PBB benefits have been identified at a case-mix (sectoral) level (Maksimovska, 2012). 67



Performance-based external audit. The development of capacity for performance audit in the region is a very recent phenomenon. It mostly relies on twinning projects with counterparts from the more advanced EU member states such as the United Kingdom, The Netherlands, and Sweden. Moreover, relevant manuals from the National Audit Office and the International Organization of Supreme Audit Institutions (INTOSAI) have been translated to prepare for the execution of performance audits. In Serbia, the State Audit Institution has only recently announced that it will conduct performance-based audits. In Croatia, it is stipulated in the law that the Supreme Audit Institution is responsible for performance audits (Art. 7). The National Audit Office Act of 2010 in Bulgaria provides a clear mandate to carry out performance audit (Art. 2 and 5). It also contains legal definitions of a “performance audit”, “effectiveness” and “efficiency”. Bulgaria has even established a Directorate for Performance Audits. In Albania, a twinning project carried out by the High State Control included four pilot performance audits and drafted a manual for performance audit (Klepsvik et al. 2013). What makes this study novel in assessing the capacity of SEE countries to introduce performance budgeting is the methodological effort to combine the analysis of the relevant budget laws, policy documents and reports of international agencies with structured questionnaires filled out by 25 respondents. The sample consists of 15 public servants from the national budget administration (three respondents from each country) and 10 fiscal experts (two respondents from each country).

The semantic differential scale asks a respondent to rate a budgetary aspect on a five-point rating scale. For instance, the respondents are asked to rank the presence of PBB-related provisions in national budget laws from 1 (no presence) to 5 (strong presence). Only one indicator – the presence of a reformconducive political environment – reflects the most recent transition indicators published in the annual transition report by EBRD (2013). Table 2 Construction of an indicator of capacity for introducing PBB in 2013 Budget aspects

Weight (in percent)

SEE average

ALB

BG

CRO

MK

SER

Legal basis for effective performance budgeting

40

3.4

2.0

4.3

4.8

3.3

2.5

PBB-related provisions in budget laws

20

2.8

1.0

5.0

5.0

2.0

1.0

Programmatic budget structure

10

5.0

5.0

5.0

5.0

5.0

5.0

Legal obligation to performance-oriented reporting

10

2.8

1.0

2.0

4.0

4.0

3.0

Financial elements

25

2.6

2.0

2.4

3.4

2.7

2.4

Quality of accounting system

10

3.0

2.0

3.0

4.0

3.0

3.0

Quality of internal audit

7.5

2.0

1.0

2.0

3.0

2.0

2.0

Constructing an indicator of capacity for introducing PBB

Presence of medium-term expenditure framework

7.5

2.6

3.0

2.0

3.0

3.0

2.0

Based on the analysis of components of performance budgeting, we are now going to synthesize them into a composite indicator that will reflect the varying progress in creating a PBB-conducive environment. All indicators are important, albeit not with an equal weight, for the final assessment. In line with the theoretical guidance, relevant empirical literature and our subjective judgment of their relative importance, we attach different weights to each category: 40 percent to the legal basis for effective performance budgeting, 25 percent to the financial preconditions in place, 20 percent to performance-oriented human resource management, and 15 percent to contextual factors (see Table 2). Within these categories, we also attach separate weights to each sub-component based on its significance. Then we construct the overall country indicator reflecting the capacity for introducing performance budgeting. Each indicator is constructed as a simple non-weighted average of the responses based on subjective assessment of the 25 respondents in our sample.

Performance-oriented human resource management

20

2.9

2.0

2.5

3.0

3.3

3.5

Quality of budget administration

5

3.2

3.0

3.0

4.0

3.0

3.0

Quality of collaboration between Ministry of Finance and line ministries

5

2.6

2.0

2.0

3.0

4.0

2.0

Training of budget executives in PBB

5

2.8

2.0

2.0

2.0

3.0

5.0

Mechanisms for motivation of executives for efficiency and performance

5

2.8

1.0

3.0

3.0

3.0

4.0

68

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Contextual factors


15

3.4

3.0

3.3

3.3

3.3

4.0

Reform-conducive political environment

5

3.6

4.0

3.0

4.0

3.0

4.0

Political will for PBB-oriented reforms

5

3.2

3.0

3.0

2.0

3.0

5.0

Performance-based external audit

5

3.4

2.0

4.0

4.0

4.0

3.0

100

3.1

2.2

3.3

3.9

3.1

2.9

Overall PBB score (weighted average)

Notes: 1 = extremely weak prospects for implementing performance budgeting; 5 = strong prospects for implementing performance budgeting. Source: Authors’ assessments based on structured questionnaires and critical review of national laws and policy documents.

A priori judgments on the relative importance of certain aspects could be criticized on the grounds of arbitrariness. Yet they reflect educated guessing about the necessary prerequisites (and institutional preparedness) for successful implementation of PBB-related reforms in the SEE region. Assuming the sample would consist only of EU member states, the relative importance of each factor would be substantially different. Another limitation of our methodology is that it does not fully take into account quality differences in a few budgetary aspects. For instance, having a medium-term expenditure framework in place does not tell much about the quality of the budget forecasts. Following the same logic, it is difficult to judge the quality of performance-based external audits and the follow-up actions based on their findings and recommendations. Lastly, key performance indicators may be developed, but rarely used to inform the budget planning process. In terms of the overall progress in implementing PBB, we draw the following conclusions: • The idea and commitment to introduce performance-based budgeting have been present for at least five years in the selected SEE countries; • All countries follow a similar approach to implementing PBB-related reforms, but with different policy attention to certain aspects (Figures 1 and 2). • The countries with more developed public financial management (Croatia and Bulgaria) are well advanced in pursuing these reforms compared to other SEE countries; • There has been no significant civil society pressure to introduce PBB, most likely because this is a long-lasting reform without instant benefits. This 70

•

• •

• •

is also in line with the previous findings by Tandberg and Pavesic-Skerlep (2009); The main differences among SEE countries are observed in their legal basis for effective performance budgeting. This reflects the different speed of budgetary reforms. For example, Serbia has no clearly stated PBB-related provisions in its budget system law, but has the strongest political will for introducing PBB and demonstrates significant progress in performancebased external audit. Generally, among all categories, the financial elements are the weakest pillar of the PBB architectures in the SEE countries. In particular, the quality of internal audit appears to be the most challenging area, which is not surprising given the history of fraud; In terms of the human resource management supporting the PBB reforms, there seems to be significant room for improvement of the quality of collaboration between the Ministry of Finance and the line ministries. The present hegemony of Finance in the SEE countries could be explained by their weak political culture and institution building; Within the contextual factors, the differences between countries are very small, due the similar political environment in SEE region. Still, in 2013, Serbia made significant kick-start steps for announcing PBB reforms; Supreme external audit institutions are more ambitious in developing performance indicators, than central government bodies are in enforcing performance-based budgeting.

Figure 1 Overall PBB scores for selected SEE countries in 2013 4.5

3.9

4.0 3.5

3.3

3.1

3.1

3.0

2.9

2.2

2.5 2.0 1.5 1.0 0.5 0.0 SEE average

ALB

BG

CRO

MK

SER

Source: Authors’ assessments based on structured questionnaires and critical review of national laws.

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Figure 2 PBB component scores for selected SEE countries in 2013

PBB is expected to significantly improve aggregate fiscal discipline and allocative efficiency of public finance in SEE countries. In order to achieve the desired outcomes, performance budgeting should be implemented gradually and on a sectoral basis. PBB reforms in SEE countries will be effective if several preconditions are met: (1) strengthening internal management control systems; (2) supporting internal audits in line with international standards, and (3) relying increasingly on modern information technologies. Political will is a conditio sine qua non. However, policymakers in the SEE region must take into account the disappointments from introducing PBB in some CEE countries. In particular, the same set of limiting (political, economic and administrative) factors that led to failures in PBB implementation can easily contribute to unfavourable PBB experiences in the SEE region. Based on the theoretical framework and subjective assessment of various components, we designed a methodology for quantifying the capacity for introducing performance budgeting in this region. The individual country scores take into account the budgetary and legislative reforms in the past five years. In sum, SEE countries have demonstrated moderate progress in implementing elements of performance budgeting. All of them follow a similar approach to embarking on these reforms, but pay different policy attention to certain aspects. It comes as little surprise that the countries with more developed public finance (Croatia and Bulgaria) are well advanced in pursuing PBB-related reforms, compared to other SEE countries. On the other hand, the SEE countries with limited progress demonstrate strong political commitment to kick-start this area by investing in skills development for their budget administration. A strong indication of the reform-conducive environment is that all the countries have introduced PBB-oriented reforms in particular sectors or line ministries through pilot projects. The financial components are the weakest pillar of the PBB architecture. More precisely, the quality of internal audit leaves significant room for improvement. Although the benefits of PBB-oriented reforms can be reaped only in the long term, the existing progress makes a sound platform for improvement of public financial management and public sector performance. The final outcome would not be immediate since the process is in its initial stages, but the SEE countries are taking proper steps to make the reforms work.

PBB-related provisions Performance-based external audit

Programmatic budget structure

Political will for PBB-oriented reforms Reform-conducive environment

Quality of accounting system 0

Mechanisms for motivation

1

Quality of internal audit

2 3

Training of budget executives in PBB Quality of collaboration

Albania

Bulgaria

4

Presence of MTEF

5

Quality of budget administration

Croatia

Macedonia

Serbia

Source: Authors’ assessments based on structured questionnaires and critical review of national laws.

CONCLUDING REMARKS Inspired by successful budgetary reforms in the economically advanced countries, there was a wave of fresh ideas for introducing PBB in the region of South-Eastern Europe during the 2008–2013 period. Still, their approach to implementing these reforms has been rather cautious, due to several political and institutional impediments. Although none of the SEE countries places PBB on the top of its government priorities, budget administrators and legal architects continuously pursue the necessary steps to improve the legal, political and economic conditions and institutional capacities for its implementation. Following the mixed experiences of OECD countries (The Netherlands, Australia, Canada, Sweden, Denmark), budgeting in SEE is not institutionally prepared to embrace more sophisticated PBB models. Therefore, we argue that the SEE region should aim to implement a simplified PBB model, an idea which has not been explored at all in the existing body of empirical literature. Its simplicity should rest on a narrow set of performance indicators; cash-based or modified cash-based accounting frameworks; better-trained budget administrators; improved motivation of government employees; and simplified performance measurement. Precisely, the simplified PBB model can help overcome the weaknesses of institutional capacity and the strong political determination for better budgeting outcomes. 72

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Relevant laws Budget Act of the Republic of Croatia (Official Gazette No. 87/08 and 136/12) Budget Act of the Republic of Macedonia (Official Gazette No. 64/05, 04/08, 103/08, 156/09, 95/10, 180/11 and 171/12). Budget System Law of the Republic of Serbia (Official Gazette No. 54/2009, 73/2010, 101/2010, 101/2011 and 93/2012). Law on Management of Budgetary System in the Republic of Albania (Official Gazette No. 9936, 26. 06. 2008). National Audit Office Act of Bulgaria (Official Gazette No.). State Budget Procedures Act of the Republic of Bulgaria (Official Gazette No. 67/6. 08. 1996, 46/10. 06. 1997, 154/28. 12. 1998, 74/30. 07. 2002, 87/1. 11. 2005, 89/8. 11. 2005, 105/29. 12. 2005, 80/5. 10. 2007, 98/14. 11. 2008, 54/15. 07. 2011, 15/15. 02. 2013).

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