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Budget Institutions in Latin America: What have we learned in the last decade?. Ernesto Stein Research Department Inter-American Development Bank. Why the interest in BI?. By 1994, when RES was created, fiscal accounts in Latin America had improved substantially:

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Budget Institutions in Latin America:What have we learned in the last decade?

Ernesto Stein

Research Department

Inter-American Development Bank


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Why the interest in BI?

  • By 1994, when RES was created, fiscal accounts in Latin America had improved substantially:

    • 1980’s deficits averaged between 5 and 10% of GDP

    • early 1990’s deficits had declined to 2 % on average, comparable to OECD.

  • Yet, there were still reasons for concern:

    • improvement partly due to cycle, privatization receipts.

    • deficits still higher than OECD when normalized by revenues

    • striking differences across countries: from 2.5 % surplus in Chile to double digit deficits in Guyana and Suriname.


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Why the interest in BI?

  • In Europe, US, similar differences in performance across fairly homogeneous countries (or states) had led scholars to explore role of BI in explaining such differences, with encouraging results.

  • So in 1994 we invited Alberto Alesina to visit RES, and together with Rudi Hommes and Ricardo, we started a project on BI and fiscal performance.


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What do we mean by BI?

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

  • These rules may take various forms:

    • numerical rules such as limits on debt or deficit

    • procedural rules, which define the attributes of the different actors that participate in budget process, and rule their interaction.

    • rules that affect the transparency of the budget.


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Why would BI matter?

  • Fiscal decisions not made by social planner.

  • They are the result of collective process involving a variety of actors, each with its own motivations and incentives.

  • This generates a number of potential problems, which good BI may help address.

    • Electoral cycle

    • Short term horizon of politicians

    • Principal-agent problems

    • The common pool problem


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The common pool problem

  • Stems from combination of two key features of public budgets:

  • Government programs generate concentrated benefits, but are financed from common pool of resources.

  • The budget is the result of a collective decision-making process, involving a variety of agents:

    • legislators, the finance minister, spending ministers, etc.

  • Since most of them represent geographical or sectoral interests, under some institutional arrangements this may lead to overutilization of the common pool, thus to excessive spending or deficits.

  • The tale of the chicken and the lobster.


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Consumption of chicken and lobster in Latin America


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How can BI address these problems?

  • Numerical rules: If enforced, may help deal with many of the problems identified above. But:

    • generate incentives for creative accounting

    • unless cyclically adjusted, may reinforce procyclicality of fiscal policy (important feature of fiscal policy in LAC).

  • Rules affecting transparency may limit agency problems by increasing accountability to voters.

  • Procedural rules may help by making process more “hierarchical”, concentrating power on those actors that have incentives to deliver fiscal discipline


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Do BI affect fiscal performance?

  • International experience suggests that they do

  • US: States with more stringent balanced budget rules have better fiscal outcomes (lower deficits, lower debt, adjust more quickly to adverse shocks)

  • EU: J. von Hagen built index of BI based on

    • relative power of FM in cabinet negotiations

    • relative power of exec. vis a vis leg. during approval

    • Degree of expenditure control by executive

  • Finds that more hierarchical BI reduce deficits and debt, without affecting capacity to stabilize output.


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Do BI affect fiscal performance?

  • LAC: AHHS built an index of BI based on a survey responded by budget directors in 20 countries.

  • We found that more hierarchical BI lead to smaller primary deficits. Similar results for deficits and debt by Stein, Talvi and Grisanti (1998).

  • Impact of BI robust, and economically important

  • So BI do matter.

  • Next question: What to do about it?


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What to do about BI in LAC?

  • Numerical rules?

    • Too inflexible for such a volatile region.

  • LAC needed solutions that would induce discipline without exacerbating procyclicality.

  • In this spirit, Eichengreen, Hausmann and von Hagen proposed creation of National Fiscal Councils

    • autonomous entity that would establish yearly debt ceilings, taking the cycle into consideration

    • additional role of setting macro assumptions, acting as autonomous scorekeeper between exec and legislature.

  • NFC proposal generated heated discussions, but no takers.


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Some recent reforms

  • Towards the end of 1990s, reform of BI started to resonate in LAC policymaking circles inspired by:

    • findings of literature

    • experience of countries such as New Zealand with its Fiscal Responsibility Act of 1994.

    • crises context that required further fiscal adjustment

  • In 1998, Venezuela created “Oficina de Asesoría Técnica del Congreso” (CBO style).

  • In 1999, Argentina and Peru adopted FRLs, combining numerical rules with stabilization funds, changes in procedures and increased transparency.


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Some recent reforms

  • In 2000, Brazil adopted very comprehensive FRL, imposing constraints not only at national level, but also at subnational levels of government.

  • In 2001, Chile adopted a 1% structural surplus rule.

  • Latecomers to the FRL game: Ecuador (2002) and Colombia (2003)


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Results have been mixed at best

  • Venezuela: CBO flourished initially, but has been subject to considerable political interference during current administration.

  • Argentina and Peru: Numerical rules component of FRL’s never complied with

    • In Peru, other aspects of the law (e.g. multiannual macro program, increased transparency) changed dynamics of the budget discussions, but overall experience can hardly be considered a success.

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

  • Chile: doing quite well under structural surplus rule

    • (but was doing well before).


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BI reform: what lessons can we draw?

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

  • Lesson 2: When it comes to the design of reforms, the devil is in the details.

    • In Argentina and Peru, some aspects of the law were very poorly designed.

      • ordinary law rather than special law (as in Brazil)

      • no enforcement mechanisms (in Brazil there are severe penalties including jail for non-compliance, and automatic trigger mechanisms to adjust behavior when targets are approached)

      • conditions for escape clauses in rules not clearly specified.


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BI reform: what lessons can we draw?

  • Lesson 3: While it may be tough to get these reforms passed, it is even tougher to make them stick.

    • Adequate implementation and enforcement requires an external enforcer (such as a capable and independent judiciary) or stakeholders interested in enforcing the rules, and powerful enough to do so.

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

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


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Budget Institutions in Latin America:What have we learned in the last decade?

Ernesto Stein

Research Department

Inter-American Development Bank


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