Accrual budgeting and fiscal consolidation in the EMU

Contemporary Economic Policy, April, 2002 by F. Javier Salinas

F. JAVIER SALINAS (*)

1. INTRODUCTION

The purpose of this article is to call attention to the important role that reforms in current national budgetary procedures play in ensuring that the fiscal consolidation undertaken in the EMU is a sustainable and credible process. Along this line, an argument is made for the fuller use of accrual concepts in member states' budget reporting.

The article concludes that accrual budgeting should be considered as a positive contribution to pursuing the stabilization of European public finances. Much more than an isolated technical exercise, fuller use of accrual concepts in budget reporting is a useful tool to facilitate wider reforms aimed at the sorely needed improvement of public sector financial management and performance while enhancing transparency and accountability.

The article is organized as follows: Section II reviews modern macroeconomic literature focusing on the study of politico-institutional determinants of public policies. Normative developments of this literature suggest three main institutional arrangements that could be conducive to fiscal discipline: (1) the existence of rules tying fiscal authority hands, (2) hierarchical budget procedures, and (3) budget transparency.

Elaborating on the aforementioned pioneering work, section III analyzes the institutional stability framework of the European Monetary Union (EMU). The Treaty of Amsterdam and the Stability and Growth Pact (SGP) provide countries in the European Union, and in particular those that have adopted the euro, with a common code of fiscal conduct that is expected to uphold discipline in the management of government finances. Nevertheless, from a political economy point of view, a simple analysis of this code of conduct shows the existence of shortcomings mainly derived from the asymmetry between the treatment given to outcomes of fiscal policy in comparison with that given to the procedures followed in generating them. It seems that the current design of the European fiscal coordination system does not really take into account the findings of modern macroeconomics and does not pay due attention to the relationship between budgetary process/institutions and outcomes in fiscal policy. Moreover, it is argued that in th e implementation of the broad reforms needed to achieve a sustainable fiscal consolidation, there are political and economic complementarities between the setting up of substantive (reduction of expenditures programs) and systemic (changes to budgetary processes) budgetary arrangements.

Section IV, after briefly recognizing the growing importance being given to fiscal rules and hierarchical budgetary institutions in the EMU, takes a closer look at the accounting transparency desirable in the current system of multilateral surveillance of national budgetary policies, and points to the potential benefits derived from a shift to accrual budgeting. Section V closes the article with some concluding remarks.

II. BUDGET INSTITUTIONS AND FISCAL PERFORMANCE

There has been recent lively literature in modern macroeconomics explaining the large variance of cross-country fiscal experiences in coping with similar economic events by focusing on the procedures that lead to the formulation, approval, and implementation of government budgets. (1) In the words of Alesina and Perotti (1995a) on the issue of cross-country differences in fiscal positions the central question to be asked is "Why did certain OECD countries, but not others, accumulate large public debts (when the economies of the OECD countries are relatively similar)?" These authors advance their own hypothesis to answer this question: "It is difficult to explain these large cross-country differences using economic arguments alone....We believe, instead, that politico-institutional factors are crucial to understanding budget deficits in particular, and fiscal policy in general" (Alesina and Perotti, 1995a, p. 2).

Consistent with the above premise, two strands of research derive from the positive analysis of this literature.

1. One avenue of research focuses on political conflict and polarization as a source of public-sector deficits, that is, it analyzes political environments where policy makers have incentives to create large deficits (Alesina and Drazen, 1991).

2. The other describes the weaknesses of political institutions, specifically of budgetary institutions, allowing large deficits to emerge (Alesina and Perotti, 1996).

These two strands of research should be regarded as complementary because they both lead to the same basic conclusion: "budget procedures and budget institutions have significant impact on fiscal outcomes" (Alesina et al., 1999, p. 255). The basic argument underlying this conclusion is that (in contrast to what is commonly assumed in traditional models of public finance) governments should not be regarded as unitary actors. Instead, governments are collective entities consisting of many different actors who do not need to share the same goals. In the current political context, at least there is a distinction between spending ministers and the minister responsible for the budget inside the executive branch of government and between the executive and the members of the legislature. Standard social choice theory informs us that unstructured collective decision making of individuals with conflicting goals is irrational, unstable, and unpredictable. Therefore, institutions play the role of generating stability and predictability. Yet in addition to that, institutions "distribute power and channel flows of information, and in doing so they shape the outcome of the policy process. This is why institutions regulating the budget process affect fiscal discipline" (Von Hagen, 1996, p. 273).