Public Finance & Economic Governance: Activities

A primary task of all governments is public sector resource mobilization, or to mobilize revenue to support the functions of the state and to serve its citizens effectively. War-torn countries face particular challenges in mobilizing revenue and restoring the provision of state goods and services - precisely when these services are needed the most. First and foremost, the underdevelopment of revenue-raising institutions, especially acute in post-conflict settings, hinders the ability of the state to mobilize resources.1

The most common form of revenue mobilization is taxation, as "mobilizing more public revenue from general taxation is crucial for extending basic service provision"2 However, in post-conflict states, taxation systems often are not functioning, or provide insufficient revenue. Diversifying revenue mobilization can ease the "revenue constraint,"3 by turning to other sources of revenue, such as customs duties, import tariffs and levies, natural resource royalities, contracts, public / private partnerships, public corporations, state owned enterprises and donor aid. In this section, these sources of public revenue are further discussed, while how acquired revenues are spent is addressed within other activities.

The expenditure side of public finance is explored here through two stages: budget design and allocation and public expenditure management. Budget design and allocation determines the allocation of resources and budget prioritizations. Public expenditure management deals with the budget decisions that will actually be implemented.4 The purpose of budget design and public expenditure management is to "maximize social returns, so as to get the most 'bang for the buck.'"5 It is also important to remember that at both stages policymakers and decision makers should maintain an eye of good economic governance ideals, such as participation, transparency and accountability.6

As a means to understanding the strategic planning aspect of public finance, this section then discusses fiscal decentralization, capacity and institution building, and finally relevant strategic frameworks.


Taxes are a critically important source of revenue for states, a means for citizens to hold governments accountable, and historically have been a means of consolidating authority in the state. Problematically, in a post-conflict setting, the very institutions, policies and systems needed to collect and manage tax revenue are destroyed by war, co-opted by varied interest groups who are not concerned with serving the public good, and/or simply totally under-capacitated and need to be built. The tax base, an indicator of the level of development, may also be particularly low following conflict. However, as the tax base increases with economic growth, more revenue can be mobilized and economic recovery can take hold, provided these resources are well used, which is of ongoing debate.7

Indirect taxes, which include sales taxes in general and value-added taxes (VAT) in particular, are the most common form of taxation. The VAT is a consumption tax on goods and services that is levied at each stage of production based on the value added to the product at that stage, usually calculated on the price of the good or service including any other tax on the product, and payable on imports of goods or services in addition to any import duties or other taxes on the imports.8 Indirect taxes can shift incidence from one payer to another. For example, a business may increase the price of a good or service in response to cover taxes levied, and so is ultimately shifting the tax burden onto the purchaser. As a result, "indirect taxes are considered regressive because they tend to affect all individuals indiscriminately, and have a greater impact on poor people due to their propensity to consume a larger share of their income. In addition, relying on indirect taxes indicates a narrow tax base and shows a failure to bring the informal sector into the formal sector (thereby increasing tax revenue)."9 Indirect taxes are in contrast to direct taxes, like income tax, whose incidence cannot be shifted, and which are typically progressive, in that they fall more heavily on richer individuals than poor ones.

There are three criticisms of the VAT relevant to the developing and post-conflict contexts. First, as noted above, the VAT does not have the progressive tax incidence of the income tax. Secondly, it has been asserted that the VAT does not function well in situations of high informality, as in most post-conflict countries.10 Finally, the VAT has been associated with fraud, particularly around export rebates11 - and unfortunately exports may be an enormous help in jumpstarting post-conflict recovery, and the revenue authority may be too unsophisticated or corrupt to prevent such fraud.

However, as income tax systems tend to have high overhead costs related to compliance enforcement and noting the small incomes of households from the formal sector in many of these contexts, the VAT represents a simpler and effective revenue generating system (generating about one-third of developing country revenues). Moreover, if VAT-derived expenditures privilege the poor, the net effect may be progressive. 12

Another important portion of government tax revenue, especially at sub-national levels, comes from the property tax, which can fund local water, sewer, communications, and transportation infrastructure. Particularly if the property tax is ad valorem (that is, a percentage of the value of fixed assets, including land and "improvements"), it may provide local revenues while also promoting the efficient use of land.13 Moreover, property taxes that go to fund local public goods that have community-wide spillover effects, thereby increasing the value of the productivity (and thus the value) of the properties in the community. Local property taxes, if spent well, are therefore thought to be "capitalized" in local property values. However, property taxes do not work well for redistributive aims because when used as such, they tend only to distort the real estate market, incenting productive units to move away from high-value locations over time.14

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Also called "customs duties," tariffs are generally imposed on imported goods (1) to discourage imports (relative to domestic production) and (2) to raise government revenue.15 Tariffs can be levied in two forms: specific and ad valorem. A specific tariff is a fixed charge on a unit of import, based on the size, weight, volume or other physical measure.16 An ad valorem tariff is a fixed percentage on the value of the commodity imported.17

Noting that monitoring major ports and border crossings is easier than all production firms and points of sale, "reforming the customs service is a priority since trade taxes account for large shares of revenue in [Sub-Saharan Africa], especially in conflict countries where external trade and tariff revenues usually hold up better during war than internal trade and sales taxes."18 Tariffs are useful for not only mobilizing revenue, but also for bolstering domestic industries and the accompanying jobs, which may be particularly important in post-conflict countries. However, tariffs limit free trade and competition, which may burden the consumer in the country of import. In addition, tariffs may impede economic growth and distort economic activity, so that there aredeadweight losses that affect consumers who have to pay higher prices.19

The international community, especially the international financial institutions (IFIs), has promoted a shift from tariffs to VATs to dismantle trade barriers and avoid distortions in the markets20 (though not without some controversy).

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Natural resource revenues

Revenue from natural resources, such as oil, gas, mining, forestry, fisheries and other primary agricultural commodities (such as coffee and cocoa), also represents a significant source of public resource mobilization for many countries.21 The use of natural resources as a potential source of public revenue, although often profitable, presents several areas of caution. According to the Publish What You Pay campaign, which promotes contract, revenue and expenditure transparency in the oil, mining and gas sectors, many countries with natural resource abundance exhibit poor governance in the management of these public revenue sources, including using low tax rates and patronage systems to crowd out accountability to their citizens.22 Dependence on natural resources can also lead to highly volatile budgets as the resources are depleted and are subject to price collapse as a result of the change in the value of these resources on the global scale. These effects diminish predictability, a previously identified pillar of economic governance. Finally, dependence on such commodities may be an unsustainable source of revenue for minor producers.

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Public private partnerships (PPP)

Many governments have incorporated the Public Private Partnerships (PPP) model as a solution for shortages in public funds.23 Usually, PPP are a way for governments to mobilize revenue by either leasing state-owned assets or paying the private sector to perform a public service where the state lacks the capacity to do so. When the private sector can deliver public goods or services more efficiently, the public benefits by lower prices and more efficient "rollout."24 "The forms public-private partnerships (PPP) in developing countries have taken are legion, ranging from the construction of physical infrastructure, to public administration, to the provision of health and social services."25 Tony Addison argues that public private partnerships can serve a useful purpose in post-conflict settings, especially when they are implemented early in the recovery process at the point where public revenue is needed the most.26

PPP traditionally take the form of concessions, or "a legal arrangement in which a firm obtains from the government the right to provide a particular service."27 Concessions are governed by state, federal and local laws and may vary in scope.28 The University of Southern California Keston Institute for Public Finance and Infrastructure Policy states that the critical question in granting concessions is, "How are public sector decision makers to know whether they are advancing the public interest when they consider these agreements?" When the government makes concessions, it is important that the "public gets the best value from long-term concession agreements...while ensuring that public interests are protected."29

Another key issue in PPP is that of procurement, which deals with contracting consultancy services, employing longer term expertise under project funding and securing non-personnel related items. The procurement process can be complex, which may discourage nascent governments from enacting a transparent and accountable system. Though ideally, the national government assumes responsibility for procurement strategies, donors may step in when there is a lack of institutional capacity.However, deferring to donors can result in "crowding out" of national capacities, which occurs when external aid impedes the capacity or the will of the state to independently and effectively manage public finances. It is critical that all actors in the procurement process closely examine unintended incentives for participation that could undermine capacity development and promote corruption.

Procurements are usually granted following a bidding process, whereby the firm that is most qualified, and at a competitive rate, is awarded the contract. However, this is not the case in many situations. Frequently, bid criterion emphasizes "the need for experience (sometimes specifying verifications such as 'cross-cultural experience') as opposed to criteria of competence such as education and management skills."30 This has the effect of excluding new local firms, as well as minority-owned firms, who may bring fresh and innovative ideas to the table. Another issue is that announcements for bids are often limited to the narrow networks of consultants or advertised through word of mouth or on a select few notice boards.31

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Land Readjustment (LR)

Land readjustment (LR) is a special case of a PPP that has particular promise for local governments seeking to develop land in post-conflict situations. It is a finance strategy for developing and upgrading land already occupied in developing countries - often facilitating the transition from rural, less intense uses to urban, more intense uses. This transition is often of prime importance in developing countries, where violent conflict may have precipitated a massive rural-urban migration.32 LR works as follows: the city or town expropriates the parcel it wishes to develop after mapping out the previous lot boundaries and valuing each of the properties. It then makes a new plan for the area whereby a certain percentage of the land-often 15% by convention-will be reserved for public improvements (e.g., roads, electric and sewerage infrastructure, parks, etc.). The remainder is divided amongst the new private interests seeking to invest, as well as the prior residents such that the value of the newly apportioned lots is equal to or (more often) greater than the previous value. The amount of land returned may be determined by real or value calculations.

In effect, the city or town has enhanced the value of the properties by improving their ability to take advantage of its agglomeration economies via roads and service delivery. Allowing the land to densify means that in extending services to peri-urban areas, densely settled areas do not overly subsidize service delivery to sparsely-settled ones. Moreover, all improvements are paid for in advance by revenues from private investors (or possibly one large private investor).

The advantages of LR over, say, simply using the power of eminent domain to make way for a public projects include:
  • The ability to retain the original community members in roughly the same location and in close proximity to one another (and involving them in a participatory redevelopment process);
  • Allowing private land markets to fund development directly;
  • Allowing the local government to pay upfront without recourse to credit when (1) the fiscal system may be weak or not publically trusted, lowering the prospects of "clawing back" public expenditures through property or land taxation, (2) the city has other urgent priorities for its account reserves, or (3) the city does not have good access to capital markets and cannot float bonds.33
The major drawback of LR in developing countries is its requirement of zoning and land use regulation enforcement, though the valuation process can be contentious in all contexts. LR has been used extensively by Germany, Taiwan, Hong Kong, and Japan (where it was employed to rebuild after World War II when municipal coffers were empty).34

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Donor aid can play a critical role in providing revenue for weak and conflict-affected states. Traditional modes of aid delivery are project aid, programming aid and technical assistance, amongst others.35 Historically, donors exhibit a strong preference to providing aid to stable governments where there is limited political or institutional liability; "achieving peace is therefore essential to maintaining aid inflows which are in turn essential to avoiding an unduly restrictive fiscal policy."36

A large influx of donor aid is common in post-conflict countries as a way to provide critical, albeit temporary, revenue for public sector functions. However, there is a growing movement to devise an exit strategy for all aid (particularly in Africa. These scholars and agencies argue that aid is undermining state responsibility. Aid can also create a situation whereby domestic resources and capacities are in effect "crowded out," creating aid dependency and reducing the likelihood of sustainable economic recovery.37 In addition, as focus on a post-conflict country wanes, aid focused on temporary relief may dry up before issues have been sufficiently handled.

However, some economists argue that donor aid can encourage sound monetary policy and stabilize inflation. First, through the goal of raising income growth, foreign aid raises domestic demand for money. Second, aid reduces the need for the government to resort to printing money to finance expenditures. Finally, aid may increase confidence in the maintenance of peace and the credibility of government policies.38

In addition to the orthodox forms of aid, debt relief has emerged within the last decade as a new modality for donor aid, especially through the Heavily Indebted Poor Countries (HIPC) Initiative. In theory, debt relief frees up resources for expenditure on public investments, a concept referred to as "fiscal space." However, this principle is only valid when countries have revenue to pay off debt. "It is important to note that these debt relief initiatives fit nicely into the new aid architecture and the aid effectiveness debate: since debt relief to low-income countries is almost exclusively for debt owed to official creditors, these creditors are the same as those that provide (traditional forms of) aid to those countries."39

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Central banks and monetary policy

"Central bank" is the generic name given to a country's primary monetary authority and usually carries the responsibility for issuing currency, administering monetary policy (including bank lending rates, with bear strongly on inflation), holding member banks' deposits, and facilitating the nation's banking industry.40 Additionally, central banks play a key role in peacebuilding, because donor aid is funneled through these institutions.41 Building the capacity of the Ministry of Finance and the central bank is considered by many to be critical in effectively managing public finances.

The independence of central banks is critical to enhance credibility in monetary policy and ensure greater financial stability.42 In many war-torn or post-conflict countries there is strong political pressure to print money in order to finance defense spending and government deficits, which can contribute to hyperinflation (i.e., the rapid, uncontrolled increase in prices linked to depreciation of the domestic currency). Inflation may result from rising real demand for goods and services due to scarcity, declining demands for money, and/or growth in the money supply. Inflation severely undermines post-conflict economic reconstruction by diminishing the ability of governments to make payments, decreasing government credibility, and directly threatening livelihoods, especially among the poorest populations.43 Recently rising global food and fuel prices have highlighted the potentially devastating impacts of inflation on the poor, increasing the incidence of starvation and social conflict.44

There are many debates surrounding the pros and cons of different monetary policies to control or prevent inflation. For example, some developing countries' monetary authorities have pegged their currency, or set a fixed exchange ratio between their currency and another international currency such as the dollar, with mixed results.45 While there is a lack of consensus on the most effective policies to control inflation, there is growing recognition of the particular vulnerability of countries recovering from conflict due to political pressure to increase money supply in order to pay for increased defense and social spending. Scholar James Boyce suggests that the relation between the inflation rate (price stability) and social stability may be inverted-U-shaped, meaning that hyperinflation erodes livelihoods, but extreme fiscal austerity leads to declines in welfare, too. This suggests that there is a "target" or optimum rate of inflation.46 An independent central bank shielded from political pressures with clear monetary policies and regulatory frameworks to help prevent excessive inflation and support sustainable post-conflict peacebuilding.47

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Budget design and allocation

Following conflict, countries are often left with weak, under-regulated financial institutions, leading to poor budget design and resource allocation.48 In order to understand the context of budget design and resource allocation in post-conflict situations, it is important to understand the general concepts of budgeting.

Budgeting is "the routines and procedures devised by governments to decide the amounts spent, the balance between revenue and expenditure, and the allocation of funds among public activities and entities."49 The key issue in budgeting is the notion of choices and prioritization. The modern conceptualization of budgeting emerged in Europe in the 1800s as a way to accommodate growing government involvement in the provision of goods and services. Since that time, budgeting had been the primary method of managing public expenditures.50

The United Kingdom Department for International Development (DFID) identifies six stages of the budget process:
  • Policy review: An annual evaluation of the results of public expenditure to inform the updating of policies and plans. This may take the form of an annual Public Expenditure Review or a legislative process involving reports to Parliament, or it may be more ad hoc.
  • Strategic planning: Setting expenditure and deficit targets, on the basis of macroeconomic projections, ideally over 3 to 5 years.
  • Budget preparation: Submission and negotiation of ministry expenditure bids within budget guidelines and expenditure limits circulated by the Ministry of Finance. This stage culminates in preparation of the budget by the Ministry of Finance and parliamentary review and legislative approval.
  • Budget execution: When the budget appropriations are approved, resources may be released to the spending agencies to implement expenditure programs. Procedures for the release of funds differ from country to country. In many developing countries funds are released in equal installments either monthly or quarterly.
  • Accounting and monitoring of expenditures and revenues: Tracking the composition and level of revenue and expenditure over the year and monitoring the outputs of expenditure.
  • Reporting and audit: The Auditor General reviews compliance with the budget, reporting in detail to the Public Accounts Committee, which advises Parliament and initiates corrective actions as necessary.51
The normal timeframe for the budget process is approximately three years and many of the stages overlap throughout the process. Additionally, governments traditionally start a new budget cycle before the current cycle is finished. "This leads to a staggering of budget cycles so that at any point in time three or more budgets will be at various stages of preparation, approval, execution and auditing."52 The challenge of overlapping budget cycles is that governments depend on previous budgets, versus actual results, to inform their decisions for the next cycle. DFID cautions that this can lead to weaknesses in the budget that compound over time.53 In addition, "Budgets are often drawn up on the basis of historical patterns, and do not reflect new priorities - especially in poverty reduction. Moreover, actual spending patterns may bear little relation to budgeted allocations due to loose expenditure control."54

A key function of budgets is to prioritize the areas the government wants to spend its resources. This decision-making process is difficult in ordinary circumstances, but is extraordinarily challenging following violent conflict when revenues are low and expenditure needs are high. In reality, budget-planning systems often fail to address the true needs of the public; rather budgets may result in unachievable "wish lists," or "projects and programmes that cannot possibly be implemented given the available or expected resources."55 However, there are few mechanisms for assisting weak governments in learning to develop budgets that are both realistic and sensitive to the needs of the public. Scholar Tony Addison recommends analyses to further understand these issues that "include benefit-incidence studies (to identify the distribution of public spending across income groups) as well as participatory poverty assessments in which communities assess the quality of services they do receive (if any) and identify priorities for new spending."56

The budget design and allocation process is, ideally, owned by the national government and supported by donors when necessary.57 Allen Schick, the international community can recommend good budgeting practices, but lacks mechanisms to actually dictate budget policies. As an example, "International advisers may caution recipient governments against excessive deficits or urge that budget allocations be shifted from one sector to another."58 However, despite this assertion that the international community has a limited role to play in designing national budgets, Schick recognizes that the IMF and other international institutions frequently assume a larger role through aid conditionality.59

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Public expenditure management (PEM)

As governments increasingly acknowledge the role public expenditures play in the achievement of designated priorities and goals, there has been movement towards the use of public expenditure management (PEM), a new framework for determining the way public resources are allocated and managed. The trend towards using PEM over conventional budgeting processes has also been driven by donor dissatisfaction of public expenditure outcomes in developing countries.60 Donors advocate for PEM as one alternative to the traditional "enclave approach," in which an agency is broken off (or created separately) from the greater government bureaucracy as a project management unit (PMU) in an attempt to increase the accountability to the donor and insulate it from wider government corruption.61 "This approach has frequently failed to bring even short-term benefits, while consistently undermining long-term institutional development."62

"Contemporary PEM theory stresses that PEM is not just about applying the procedures of the budget process to share out available resources but about using public expenditure to best achieve policy goals."63 PEM also encourages "behavioral norms for allocating and controlling public expenditure."64

The basic elements of public expenditure management are:
  • Aggregate fiscal discipline:"Budget totals should be the result of explicit, enforced decisions; they should not merely accommodate spending demands. These totals should be set before individual spending decisions are made, and should be sustainable over the medium-term and beyond."65
  • Allocative efficiency:"Expenditures should be based on government priorities and on effectiveness of public programs. The budget system should spur reallocation from lesser to higher priorities and from less to more effective programs."66
  • Operational (productive) efficiency: "Agencies should produce goods and services at a cost that achieves ongoing efficiency gains and (to the extent appropriate) is competitive with market prices."67
PEM is rooted in the budget decision-making process but differs in two key ways. First, government must not only go through the steps of budgeting; under PEM, they must also link the budget to desired policy outcomes.68 These outcomes are functions of total revenue and expenditure, allocation of resources among sectors and programs, and the efficiency with which government institutions operate.69 Second, PEM expands the scope of institutional and management arrangements beyond traditional budgeting institutions.70

However, like orthodox budgeting, PEM involves making difficult choices on how to spend public revenues. "Public money must be spent on core pro-poor services: primary education, basic health services, and safe water and sanitation. But hard choices still exist within these priorities. Until revenues increase, it may not be possible to simultaneously restore basic infrastructure. One must be chosen over the other - an undesirable state of affairs."71 Though "public expenditure reform is crucial to reconstruction since it creates new mechanisms to improve resource use,"72 public service expenditure is significantly lower in conflict-affected countries than in non-conflict countries.73 This means that some of the countries faced with the greatest need for public goods and services lack the resources to implement these programs, even when the government wishes to prioritize them.

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Sector wide approach (SWAP)

A sector wide approach (SWAP) to budgeting has recently become more common as a way to improve coordination between key sectors.74 "The defining characteristics of a

sector programme are that all significant funding for the sector supports a single sector policy and expenditure programme, under Government leadership, adopting common approaches across the sector, and progressing towards relying on Government procedures to disburse and account for all funds."75 In effect, a SWAP attempts to combine the short-term advantages of the "enclave approach" (e.g., a specialized focus on policy objectives) with the long-term advantages of PEM (e.g., budget sustainability - a goal that SWAP progresses towards).

A sector wide approach aims to raise the effectiveness of public investments and budget transparency by better management of capital investments.76 Interestingly, SWAPs are used almost exclusively in highly indebted and aid dependent countries because their approach seems appropriate in contexts in which existing institutional infrastructure requires a comprehensive overhaul, rather than remedying a few distinct shortcomings. Moreover, their policy objective orientation is particularly conducive to donor-funded projects, while seemingly avoiding the unevenness, inconsistency and redundancy of implementing a larger number of small projects. "Roughly 80 sector programmes are being prepared and implemented, 85% of them in Sub Saharan Africa."77 This shows an increased attention to coordination and buy-in of governance structures. SWAP also aims to improve public investment by prioritizing expenditures on health and education, which usually account for over half of the total of sector-wide budgets. Such focuses are in contrast to the usual budgetary priorities of post-conflict countries, which often see cutbacks in these "nonessential" areas, while defense expenditures increase. Additionally, there have been SWAP programs in agriculture, energy, environment, urban development and water.78

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Public investment

A fundamental role of all governments is to provide public goods and services that are not available through efficient means through the private sector; this is called public investment.79 Public investment involves both physical infrastructure, such as roads and electricity grids, and institutional infrastructure, which builds the capacity of the state to provide education, health care, public safety and rule of law.80 Public investment is especially crucial to post-conflict recovery and reconstruction; however, "governments and donors sometimes focus on highly visible social programmes which nevertheless have limited coverage, and avoid the hard choices necessary to resource basic services."81

Exacerbating this is a trend toward failing to re-calibrate public investment in the post-conflict period. During conflict, the average developing country, defined as a country with less than US$3,000 per capita gross domestic product (GDP) in 1995 dollars, spends about 5 percent of the GDP on the military. This figure should drop to 2.8 percent of during peace time; however, governments often fail to decrease military expenditures to peacetime levels.82

An additional issue in public expenditures and public investment is one of predictability and planning. "Capital investments are made without budgeting sufficient recurrent funds resulting in schools without books, clinics without basic drugs, and roads without maintenance. This problem is exacerbated when donors finance capital investment without due consideration to their recurrent budget implications...and by instability in public revenues - caused by fluctuations in the prices of commodity-exports - which generates instability in public expenditures."83

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Fiscal decentralization

Decentralization can be defined as a transfer of power from central government to local actors who are closer, and presumably more responsive, to those impacted by public spending decisions.84 Over the last two decades, decentralization has "emerged as one of the most important trends in development policy. Decentralization is a global and regional phenomenon, and most developing and transitional counties have experimented with it to varying degrees."85

Specifically, fiscal decentralization implies resource reallocation to sub-national levels of government, whether by intergovernmental transfers or the conference by the central government of increased taxation authority to local government. 86 It shifts the burden of expenditure and goods and service provisions from the central government's shoulders and onto subnational governments, "which are often underutilized and have untapped revenue potential."87 In the theory of fiscal federalism, central government must take care of macroeconomic stabilization and redistributive policies because, in the first local governments have too-open economies and lack the monetary and exchange rate prerogatives to contain the effects of fiscal stimulus and, in the second case, the mobility of people and firms makes redistributive policies on the local level inefficient. However, those goods and services that are solely consumed within the jurisdiction of the sub-national government are good candidates for decentralization.88 Decentralization is thus the complex process of finding a fit between the extent to which a public good "spills over" geographically, and the level of government responsible for it.89

Fiscal decentralization, as with decentralization more broadly, should be implemented with consideration of the institutional context, including "the overall economic development, the nature of the legal system, ongoing process of economic and political reform, the organization of monetary and financial institutions, and tensions arising from ethnic, religious, or economic differences."90 As a result of these varied contexts, "there is no ideal model of decentralization."91 In addition, these institutional differences make it is difficult "to measure and compare the degree of decentralization across countries and to make generalizations about it."92 Ultimately, this means that the true effectiveness of decentralization in promoting better public resource management and economic growth may still be unknown.

There are a number of concerns related to the potentially destabilizing nature of fiscal decentralization. First, fiscal decentralization tends to increase disparities between sub-national levels of government. This is a natural tendency of allocative efficiency playing to the "preferences" of those with different incomes - assuming no overriding cultural affinities, sub-national governments offering more and better services will attract wealthier residents, and the reverse is also true. Therefore, as noted above, local governments are constrained in their ability to redistribute income, and must rely on the central government for that function.93 Second, a great deal of fiscal decentralization can actually make macroeconomic stabilization more difficult for the central government, because the central government's share of national taxes and expenditures must be large enough for its ebbs and flows to have some effect.94 Third, the hypothesis of increased allocative efficiency is predicated upon a number of assumptions that are unlikely to be true in a developing country, including (1) great household mobility, (2) preferences vary idiosyncratically (and not by income), (3) residents will express their preferences by voting, (4) local elected officials will act on those preferences, and (5) local elected officials have the power to persuade local government to act accordingly. Fifth, productive efficiency of service and goods provision may suffer dramatically on the local level without economies of scale and scope gained at the national level.95 Finally, decentralization may increase corruption, because local governments tend to have less professionalized bureaucracies.

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Capacity development and institutional reform

The United Nations Development Group (formerly UN DGO, now "DOCO") uses the OECD/DAC definition of capacity as "the ability of people, organizations and society as a whole to manage their affairs successfully, and 'capacity development' is understood as the process whereby people, organizations and society as a whole unleash, strengthen, create, adapt and maintain capacity over time."96 Within this definition, capacity development is organized on three levels: human resource development, organizational development, and institutional and legal frameworks.97 In this sense, the commonly used term "institution building" can be considered to be a sub-category of capacity development, although these terms, along with statebuilding, are used somewhat interchangeably in the peacebuilding literature.

Following conflict, budgetary institutions are often profoundly weak.98 "Institutional development in the financial sector is particularly important not only because of the role of efficient and sound financial systems in promoting economic development, but also in view of the fact that with globalization the quality of the institutional financial framework is crucial for countries to reap the benefits of international capital flows and to minimize the costs of volatility and contagion."99

Anti-corruption strategies may also require institution building from the ground up. One proposed mechanism is the creation of "an independent anti-corruption commission, which has broad investigative capabilities (including arrest, detention, search and seizure) and prosecutorial powers, as well as a public education mandate."100However,the effectiveness of such bodies is questionable; according to a United Nations Development Programme (UNDP) book on capacity building, there are "very few examples of successful independent anti-corruption commissions."101 To supplement or complement such institutions, UNDP also recommends that the Office of the Auditor-General, Office of the Ombudsperson and Office of the Contractor General (or National Tender Board) be strengthened to minimize corruption and increase economic good governance.102 Additionally, an independent judiciary and strong legislative mechanisms are needed to encourage accountability and transparency.103

The sequencing of fiscal policy reforms and financial institution building following conflict remains a highly contested debate, with large spread disagreement on which process should come first on the peacebuilding agenda.

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Strategic frameworks

Poverty Reduction Strategy Papers (PRSPs)

Emanating from a 1999 meeting of the G7 countries, in connection with the approval of the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative, the Poverty Reduction Strategy Paper (PRSP) seeks to reduce poverty and serve as a framework for development assistance.104 Issues of economic governance and finance manifest in different ways these strategic frameworks. According to Fantu Cheru, a UN independent expert on the effects of structural adjustment, the good governance areas of PRSPs typically deal with all levels of governance, but in terms of economic governance, states prioritize decentralization and fighting corruption. In the realm of public finance, PRSPs often seek to reduce poverty "by implementing fiscal, monetary and exchange rate policies to maintain low inflation and competitiveness; improving the management of public expenditure; mobilizing additional budgetary resources; securing and expanding financial markets; and the promotion of international trade and competitiveness."105

Go to Economic Recovery: Economic Recovery Strategies- Strategies and Models: PRSPs

The World Bank's criteria for assessment of PRSP quality also provide insight into public finance and economic governance in PRSPs. The agency looks at the quality of development information, stakeholder access to information, and coordinated country-level monitoring and evaluation. Thus, transparency and accountability are clearly priorities for PRSPs. In addition, the World Bank argues that linking budgets to national development strategies is a key determinant for achieving success. However, the World Bank assessment of PRSPs found that "many countries have taken initial steps toward performance-oriented budgeting, but in most countries strategies are still only weakly linked to the budget. Strengthening the links between national development strategies and budget allocation remains a major problem for most countries."106

The World Bank recommends the use of medium-term expenditure frameworks (MTEFs), as a way for counteracting this failure. On the other hand, Cheru argues that the MTEF is often "disjointed from the budget process and does not act as a real budget constraint."

Also of importance are the connections between PRSPs, HIPC, conditionality and debt relief. According to a UNU-WIDER paper, "It is well known that the HIPC Initiative has come about with a heavy and diversified portfolio of conditionality, including not only broad macroeconomic and structural reforms through the conventional IMF programme, but with broad poverty focus through the poverty reduction strategy papers (PRSP), and country-specific tracking mechanisms to monitor the use of HIPC debt savings."107 In other words, donors wants to ensure that the "fiscal space" created by debt relief is used by states for public investment programs, such as education and health services. However, some critics argue that PRSPs and debt relief are just another form of conditionality and undermine true national ownership and participation.

Go to Economic Recovery: Public Finance- Debates: Debt relief

Country Financial Accountability Assessments (CFAAs)

Country Financial Accountability Assessments (CFAAs) are a World Bank financial management diagnostic tool that seeks to describe and assess a country's financial accountability systems in both the public and private sectors. In particular, CFAAs assess the strengths and weaknesses of accountability arrangements for a country's management of public resources and identifies the risks that these arrangements "may pose to the use of World Bank funds."108 CFAAs are employed primarily in Eastern Europe and Central Asia.

Medium-Term Expenditure Framework (MTEF)

Recently, the usage of the Medium-Term Expenditure Framework (MTEF) as a way to plan and manage national budgets has gained popularity in the developing world, especially in Africa. MTEF is promoted by the World Bank as a more comprehensive framework than previous budgeting schemes.109 Many argue that orthodox budgeting methods are ineffective, because they fail to link priorities with fiscal realities and are based on annual cycles that may not reflect the true macroeconomic environment. MTEF seeks to address these shortcomings in budgeting. "In principle, [a MTEF] links policymaking, planning and budgeting, thereby allowing expenditures to be driven by policy priorities and disciplined by budget realities, injecting a medium-term perspective and allowing for policy choices that enhance long-term development."110 MTEF is a rolling budget that covers three years and is comprised of several sub-frameworks: macroeconomic framework with a forecast of revenues and expenditures in the medium term, a multiyear sectoral programme with cost estimates, a strategic expenditure framework, a plan for allocating resources among sectors and detailed sectoral budgets.111

Go to Economic Recovery: Public Finance- Actors: National governments; Activities: Strategic frameworks: PRSP and Activities: Public finance expenditure management

Consulting Africa, a firm with expertise in the field, conceives of MTEF as a four-stage process that involves "Top Down" responses from the Ministry of Finance and cabinet and "Bottom Up" activities from sector ministries. Examples of top down activities include projecting total resources for a three year period, both domestic and donor and dividing these resources between sectors and ministries on the basis of government priorities and policies. Bottom up activities would involve ministries estimating the costs of implementing policy and achieving agreed outputs through the preparation of three year, integrated, performance based budgets, providing this information back to the Ministry of Finance and cabinet so that adjustments in the allocations between sectors and basing ministries on the costs of implementing priority policies and programs.112

Within these stages, there are three levels of development of a MTEF. The first is a Medium Term Fiscal Framework (MTFF), which contains a statement of fiscal policy objectives and a set of integrated medium-term macroeconomic and fiscal targets and projections. The second stage, a Medium Term Budget Framework (MTBF) builds upon the MTFF by allocating funds to spending agencies to meet the nation's identified expenditure priorities. Essentially, a MTBF is a Medium Term Expenditure Framework (MTEF) at its most simplistic form. Finally, a MTEF expands upon the MTBF by identifying specific activities and outputs.113

According to a United Nations Economic Commission for Africa (UNECA) report, "The advantages of the MTEF include improved macroeconomic stability through fiscal discipline, better intra- and inter-sectoral resource allocation, effective prioritisation of expenditures on the basis of clearly articulated socioeconomic programmes, greater budgetary predictability, more efficient use of public finances, greater accountability for the outcomes of expenditures and greater credibility in budgetary decision-making."114 Additionally, Tony Addison argues that MTEFs are a way for states to better utilize donor aid and funds released by debt relief.115

Initial studies have found limited success for MTEF in Africa; however, a World Bank study "suggests that at least 12 years are needed before the MTEF's impact can be realistically assessed. It is necessary to wait several more years before a meaningful assessment of the MTEF in other African countries can be conducted." It is further difficult to gauge the success of these framework because few MTEFs are actually fully operational.116 From the data available, some critics argue that MTEFs fail to improve macroeconomic stability; fail to reallocate resources between sectors; fail to deliver predictability; and are too rigid and inflexible.117

The World Bank Public Finance website provides country reports of MTEF.

1. Tony Addison, From Conflict to Recovery in Africa (Oxford: Oxford University Press, 2003), 243.
2. Ibid.
3. Ibid., 248.
4. James K. Boyce and Madalene O'Donnell, "Peace and the Public Purse: An Introduction," in Peace and the Public Purse: Economic Policies for Postwar Statebuilding," ed. James K. Boyce and Madalene O'Donnell (Boulder: Lynne Rienner Publishers, Inc., 2007), 9.
5. Ibid.
6. Ibid.
7. Ibid., 256.
8. UN, "Definition of: Value Added Tax," United Nations Statistics Division.
9. United Nations Economic Commission for Africa (UNECA), "African Governance Report 2005," Addis Ababa: UNECA, 59.
10. J. Piggott and J. Whalley, "VAT Base Broadening, Self Supply, and the Informal Sector," American Economic Review vol. 91, (2001): 1084-1094.
11. Michael Keen, "VAT Attacks!" International Tax and Public Finance vol. 14, no. 4 (2007): 365-381.
12. Reuven Avi-Yonah and Yoram Margalioth, "Taxation in Developing Countries: Some Recent Support and Challenges to the Traditional View," Virginia Tax Review (Summer 2007).
13. Anne Paugam, "Ad Valorem Property Taxes in Transition Economies," Working Paper No. 9, Infrastructure Unit - Europe and Central Asia, World Bank (1999).
14. Wallace E. Oates, "Property Taxation and Local Government Finance: An Overview and Some Reflections," in Property Taxation and Local Government Finance (Cambridge: Lincoln Institute of Land Policy, 2003), 21-22.
15. Government of Canada, "Economic Concepts: Tariffs," Government of Canada.
16. Ibid.
17. Steven M. Suranovic. "Import Tariffs: International Trade Theory and Policy" The International Economics Study Center, Washington DC: George Washington University; Government of Canada, "Economic Concepts: Tariffs."
18. Addison, From Conflict to Recovery in Africa, 243-244.
19. Government of Canada, "Economic Concepts: Tariffs."
20. Boyce and O'Donnell, "Peace and the Public Purse: An Introduction," 7.
21. UNECA, "African Governance Report 2005," 59.
22. Publish What You Pay (PWYP), "Mission: A Global Campaign for Revenue Transparency in the Oil, Gas & Mining Industries," PWYP.
23. Stephen Thomsen, "Encouraging Public-Private Partnerships in the Utilities Sector: The Role of Development Assistance," NEPAD/OECD Investment Initiative (May 25-27, 2005), 3.
24. Department of Foreign Affairs, "Address of the South African Minister of Foreign Affair, Dr Nkosazana Dlamini Zuma, on Public Private Partnerships: The South African Experience," Tokyo International Conference for African Development IV Ministerial Preparatory Meeting, Libreville: Republic of South Africa (March 21, 2008).
25. Thomsen, "Encouraging Public-Private Partnerships in the Utilities Sector," 3.
26. Addison, From Conflict to Recovery in Africa, 244.
27. Michael Klein et al., "Concessions for Infrastructure: A Guide to Their Design and Award," The World Bank: Finance, Private Sector and Infrastructure Network, Technical Paper 399.
28. US Legal Definitions, "Concession Law and Legal Definition," US Legal, Inc.
29. University of Southern California (USC) Keston Institute for Public Finance and Infrastructure Policy, "Protecting the Public Interest: The Role of Long-term Concession Agreements for Providing Transportation Infrastructure," USC Keston Institute for Public Finance and Infrastructure Policy, June 2007.
30. Carlos Lopes and Thomas Theisohn, Ownership, Leadership and Transformation: Can We Do Better for Capacity Development? (New York: United Nations Development Programme and Earthscan Publishers Ltd., 2003), 112.
31. Ibid., 113.
32. Mathias Czaika and Krisztina Kis-Katos, "Civil Conflict and Displacement: Village Level Determinants of Forced Migration in Aceh," Discussion Paper No. 4 (Freiburg: Department of International Economic Policy, University of Freiburg, April 2008), 13.
33. Topher L. McDougal, "Development during Crisis: Promoting Asset-Building in Protracted Refugee Situations," MIT International Review (Spring 2007).
34. Ling-Hin Li and Xin Li, "Land Readjustment: An Innovative Urban Experiment in China," Urban Studies vol. 44 no. 1 (2007): 81-98.
35. Danny Cassimon and Bjorn Van Campenhout, "Aid Effectiveness, Debt Relief and Public Finance Response: Evidence from a Panel of HIPCs," Research Paper No. 2007/59, Helsinki: United Nations University World Institute for Development Economics Research, (September 2007), 1.
36. Ibid., 255.
37. Boyce and O'Donnell, "Peace and the Public Purse: An Introduction," 6.
38. Christopher Adam, Paul Collier and Victor Davies, "Post-Conflict Monetary Reconstruction," Department of Economics: Oxford University, September 29, 2006.
39. Cassimon and Van Campenhout, "Aid Effectiveness, Debt Relief and Public Finance Response: Evidence from a Panel of HIPCs," 1.
40. The Organisation for Economic Co-operation and Development, "Central Bank" in Glossary of Statistical Terms.
41. Peacebuilding Commission, "Buttressing the State's Fiscal Capacities: Comparative Lessons from Budget Support," United Nations Peacebuilding Commission, Working Group on Lessons Learned (November 8, 2007), 2.
42. Andrew B. Abel and Ben S. Bernanke. Macroeconomics. Fifth Edition (Boston: Pearson Education Inc., 2005), 462.
43. Martha Starr, "Monetary Policy in Post-Conflict Countries: Restoring Credibility," American University, May 2004, 3.
44. The World Bank estimated that the food crises could contribute to the spreading of social unrest to 33 countries. The cost of food and fuel has already been cited as a factor leading to violence in Haiti, protests by Argentinean farmers and riots in sub-Saharan Africa, including attacks on immigrants in South African townships. See "As Food Prices Soar, Hunger and Unrest Prompt Global Concern," Oxfam America (April 18, 2008).
45. Guillermo A. Calvo and Carment M. Reinhart, "Fear of Floating," National Bureau of Economic Research, Working Paper No. 7993 (November 2000).
46. James K. Boyce, "Post-Conflict Recovery: Resource Mobilization and Peacebuilding," Working Paper 159, Political Economy Research Institute, UMASS-Amherst (February 2008), 8.
47. Gerd Junne and Willemijn Verkoren, Postconflict Development: Meeting New Challenges, (Colorado: Lynne Rienner Publishers, 2005), p. 216-18.
48. Joseph Stiglitz, Globalization and Its Discontents, (New York: W.W. Norton and Company, Inc., 2003), 128.
49. Allen Schick, A Contemporary Approach to Public Expenditure Management (Washington DC: The World Bank Institute, 1998), 1.
50. Ibid., 3.
51. United Kingdom Department for International Development (DFID), "Understanding and Reforming Public Expenditure Management: Guidelines for DFID," (London: DFID, March 2001), 10.
52. Ibid.
53. Ibid.
54. Addison, From Conflict to Recovery in Africa, 242.
55. Ibid.
56. Ibid.
57. Mick Foster, "New Approaches to Development Co-operation: What Can We Learn From Experience With Implementing Sector Wide Approaches," Working Paper 140, (London: Overseas Development Institute, October 2000) 9.
58. Ibid.
59. Ibid.
60. Ibid., 2.
61. Shahid Amjad Chaudry, Gary James Reid, and Waleed Haider Malik, "Civil Service Reform in Latin America and the Caribbean," Technical Paper 259, (Washington DC: World Bank, 1994).
62. DFID, "Understanding and Reforming Public Expenditure Management: Guidelines for DFID," 4.
63. Ibid., 12.
64. Schick, A Contemporary Approach to Public Expenditure Management, 3.
65. Ibid.
66. Ibid.
67. Ibid.
68. Ibid.
69. Ibid
70. Ibid
71. Addison, From Conflict to Recovery in Africa, 247-248.
72. Ibid, 263.
73. Ibid, 242.
74. Ibid, 248.
75. SHC Development Consulting, "Sector Programmes and PRSP Implementation: Chances and Challenges," (paper commissioned by KfW for the Strategic Programme with Africa, Kassel: SHC Development Consulting, December 2001), iii.
76. Addison, From Conflict to Recovery in Africa, 248.
77. Foster, "New Approaches to Development Co-operation," 9.
78. Ibid.
79. Boyce and O'Donnell, "Peace and the Public Purse: An Introduction," 7.
80. Ibid 9.
81. Addison, From Conflict to Recovery in Africa, 248.
82. Collier, Paul et al., Breaking the Conflict Trap: Civil War and Development Policy (Washington, DC: World Bank and Oxford University Press, 2003).
83. Addison, From Conflict to Recovery in Africa, 242-243.
84. Anne M. Larson. and Jesse C. Ribot. "Democratic Decentralisation through a Natural Resource Lens: An Introduction." European Journal of Development Research vol. 16 no. 1 (2004), 3; T. Sisk et al eds., Democracy at the Local Level: The International IDEA Handbook on Participation, Representation, Conflict Management and Governance (Stockholm: International Institute for Democracy and Electoral Assistance (International IDEA), 2001), 221; Wallace E. Oates, "An Essay on Fiscal Federalism," Journal of Economic Literature vol. 37 (1999): 1120.
85. Ibid.
86. Ibid.
87. Ibid.
88. Oates, "An Essay on Fiscal Federalism," 1121-1122.
89. Rmy Prud'homme, "The Dangers of Decentralization," The World Bank Research Observer vol. 10 no. 2 (1995): 201-220.
90. Ibid.
91. Kempe Ronald Hope, Sr., "Building a Peaceful and Sustainable Future: Democratic Governance, Decentralization and Reconstruction in Southern Africa," International Development Resource Centre Project 100142 (Botswana: African Development Studies Association, October 2000), 4.
92. The World Bank Group, "Concept of Fiscal Decentralization and Worldwide Overview: Introduction," (Washington DC: World Bank Institute, Intergovernmental Fiscal Relations and Local Financial Management Program).
93. Prud'homme, "The Dangers of Decentralization," 202.
94. Ibid., 205.
95. Ibid., 207-209.
96. United Nations Development Group (UNDG), "Enhancing the UN's Contribution to National Capacity Development: An UNDG Position Statement," United Nations Development Programme, October 2006.
97. Ibid.
98. Addison, From Conflict to Recovery in Africa 242.
99. Boyce and O'Donnell, "Peace and the Public Purse: An Introduction," 6.
100. Ibid.
101. Ibid., 118.
102. Ibid., 118.
103. Ibid., 119.
104. Fantu Cheru, "Building and Supporting PRSPs in Africa: What Has Worked Well So Far? What Needs Changing?" Third World Quarterly, vol. 27, no. 2 (2006), 355.
105. Ibid., 358-359.
106. The World Bank, Results-based National Development Strategies: Assessment and Challenges Ahead (Washington DC: The World Bank, December 2007), xvi.
107. Cassimon and Van Campenhout, "Aid Effectiveness, Debt Relief and Public Finance Response: Evidence from a Panel of HIPCs," 4.
108. The World Bank, "Country Financial Accountability Assessments (CFAAs)," The World Bank.
109. UNECA, "African Governance Report 2005," 57.
110. Ibid.
111. Ibid.
112. Consulting Africa, "Medium Term Expenditure Framework," Consulting Africa.
113. Oxford Policy Management, "Medium Term Expenditure Frameworks- Panacea or Dangerous Distraction?," OPM Review, Paper 2, (May 2000), 2.
114. Ibid., 58.
115. Addison, From Conflict to Recovery in Africa, 250.
116. UNECA, "African Governance Report 2005," 59.
117. Consulting Africa, "Medium Term Expenditure Framework."

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