National Fiscal Management Plan

1. National Fiscal Management Plan October 10, 2003 Youngsun Koh Korea Development Institute

2. Introducing the National Fiscal Management Plan The Korean government is currently preparing “National Fiscal Management Plan (2004-2008)” that will be published at the end of this year. The Plan specifies the size of aggregate expenditure up to year 2008 in terms of the consolidated central government and the general account. The size was determined with a view to restraining expenditure growth and guaranteeing long-term fiscal sustainability. Each year, the government will prepare the budget within the expenditure limit set out in the Plan.

3. Introducing the National Fiscal Management Plan The Plan also specifies the budget allocation in 14 areas up to year 2008. The medium-term allocation plan reflects the policy-priority of the present government. Each year, line ministries will be required to submit their budget bids within 110% of the specified allocation. The actual allocation will be determined by the budget authority (MPB) and approved by the parliament.

4. Characteristics of the previous budget process No medium-term anchor that guides the annual budget preparation: - The only principle was that of “expenditure within revenue,” which can be rephrased as “balanced budget for every year.” - Fiscal policy is prone to a pro-cyclical management because an economic upturn implies a larger revenue and a larger expenditure. - Line ministries’ planning capacities are severely limited because of the uncertainty surrounding the amount of their future resources.

5. Characteristics of the previous budget process Excessive reliance on a bottom-up approach in budgeting: - Line ministries usually ask for a budget increase of around 30%. - MPB then enters into laborious negotiations with line ministries, examining about 4,000 budget items. - Examinations result in a massive cut in budget requests. - This practice fosters incrementalism in budgeting and makes the strategic reprioritization difficult. - It also provides little incentive for line ministries to economize on their spending. (Ask for money whether or not you really need it!)

6. Characteristics of the previous budget process Narrow focus on the general account: - The budget examination is usually focused on the general account. For example, the size, the balance, and the allocation of the budget are usually stated in terms of the general account. - It is difficult to identify the impact of the total fiscal activities of the government on the economy and its decision-making may be distorted.

7. Benefits of the new expenditure framework The new expenditure framework is expected to provide: - A medium-term anchor for aggregate expenditure control and sectoral allocation of budget. - Greater flexibility in the adjustment of budget balance to the changing economic conditions. - Easier reprioritization of the budget and a stronger link between policies and budget allocation. - An incentive for line ministries to economize on their spending and build their planning capacities.

8. The Need for the transition to the new framework The financial health of the government deteriorated markedly after the economic crisis of 1997, calling for a medium-term fiscal consolidation strategy. Budget balance Central government liabilities Source: Ministry of Finance and Economy Source: Ministry of Finance and Economy

9. The Need for the transition to the new framework More worrying is the trend growth in expenditure, which will accelerate with the aging of the population. Expenditure growth General government expenditure Source: Ministry of Finance and Economy Note: The data for Korea and Japan refer to 2000. Others refer to 2001. Source: OECD, Economic Surveys: Korea, Volume 2003/5-March.

10. The Need for the transition to the new framework At the same time, a strategic reprioritization of expenditure is required to meet the changing demand in the society. In particular, spending on economic affairs should be scaled down to accommodate rising welfare expenditures. Functional classification of spending (% of the central government expenditure and net lending) Education Defense Welfare Economic (Transportation) Affairs (Agriculture) (Others) ’70 16.7 22.7 4.9 27.4 (11.2) (7.9) (8.3) ’80 14.6 30.6 5.7 26.0 (5.9) (6.7) (13.4) ’85 16.6 26.6 5.2 21.9 (8.3) (6.4) (7.2) ’90 17.0 20.0 8.1 20.4 (10.2) (6.1) (4.1) ’95 18.0 15.7 9.0 24.9 (11.2) (8.5) (5.2) ’00 15.3 11.4 15.3 25.2 (6.2) (9.9) (9.1) Source: Ministry of Finance and Economy

11. The Need for the transition to the new framework The net spending of special accounts and public funds has increased substantially over the years in relation to that of the general account, making the narrow focus on the latter all the more inappropriate. Expenditure and net lending by accounts Source: Ministry of Finance and Economy.

12. The Need for the transition to the new framework The relationship between the budget authority and line ministries is undergoing a change. - The scope and complexity of line ministries’ missions has increased, making it ever more difficult for the budget authority to control the microscopic details of their activities. - Too much emphasis on spending control is likely to limit the capacity of the budget authority to analyze and understand the policy content of the budget. - A more macroscopic approach to budgeting is therefore needed.

13. The Need for the transition to the new framework The relationship with the parliament is also changing. - With the democratization of the Korean politics, the National Assembly is playing a larger role in policy-making in general and budget-formulation in particular. - The larger role of the parliament can act to reduce the centralizing power of the budget authority in the terminology of von Hagen and Harden (1996) and work against fiscal consolidation. - An expenditure limit that binds the parliament as well as the executive branch will provide a useful to control the spending growth.

14. The new framework as a solution The new expenditure framework will make it possible for the budget authority to - Restrain the spending growth by specifying the expenditure limit for coming years that will be fixed in nominal terms; - Reprioritize the sectoral allocation of budget in a strategic way with the medium-term allocation plan; - Move away from the microscopic control of line ministries’ activities and toward an in-depth review of policies; and - Set up binding targets for both the legislative and the executive branches.

15. Macroeconomic management of the fiscal policy The government aims to stabilize the balance excluding social security funds and the repayment of guaranteed debts, allowing its cyclical fluctuation around the projected trend. Budget balance Central government liabilities

16. Budget time table under the new framework The new framework will entail changes in the budget time table. - December: MPB transmits guidelines to line ministries on how to prepare a medium-term expenditure forecasts under the assumption of no policy change. - January-March: Line ministries prepare expenditure forecasts. MPB collects the forecasts, examines new spending needs, and prepares a plan for the sectoral allocation of budget for the next fiscal year.

17. Budget time table under the new framework - March: The cabinet decides on the size of total expenditure and its sectoral allocation, and submits the National Fiscal Management Plan to the parliament, which is subsequently approved. MBP transmits the budget preparation guideline to line ministries. - April-May: Line ministries prepare budget bids. - June-August: MPB negotiates budget bids with line ministries and prepares the draft budget. - September-October: The draft budget is approved by the cabinet and submitted to the parliament. - December: The parliament approves the budget.

18. Budget time table under the new framework The new budget time table implies that - The budget preparation work by MPB will be spread out over the year rather than being bunched up around June-August as is the case now; and - Line ministries will be informed of the total amount of available resources at the early stage of budget preparation, and their work will be accordingly carried out in a more orderly fashion.