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Fiscal discipline and budgetary analytical capacity in the euro area

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Fiscal discipline and budgetary analytical capacity in the euro area

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In the aftermath of crises, the state of public finances, the quality of budgetary surveillance, and the determinants of fiscal discipline typically regain prominence in the policy agendas. This happened in the EU and the euro area in two recent instances: after the recession that began in 2008 and extended until 2012 (Wyplosz 2010, Fatás and Mihov 2010), and after the Covid-19 crisis in early 2020 (Baldwin and Weder di Mauro 2020).

In parallel, budgeting is becoming an increasingly complex process. The amount of information that ought to be considered has increased and growing uncertainties of all sorts demand a quicker reaction from what is still the key public policy instrument – the public budget. Accomplishing budgeting properly depends more and more on the analytical capacities of budgetary decision makers. The exercise of these capacities can be facilitated or hampered depending on certain features of the budgetary process. How comprehensive, up-to-date, and independent are the macroeconomic and fiscal projections? What is the quantity and quality of information provided to the legislature to scrutinise the executive? How transparent is the whole budgeting process?

To date, most of the research on the determinants of fiscal discipline has focused on two explanatory factors: statutory budgetary rules and political-economy determinants. The former covers, for instance, the rules of budget negotiation, voting and approval, and the functioning of central budget authorities (Perotti and Kontopoulos 2002, Persson and Tabellini 2003, Alesina et al. 2006, Cheibub 2006, Wehner 2010). The latter analyses, among other issues, the type of political system, the executive and legislative fragmentation, or the timing of political cycles (Alesina and Perotti 1999, Volkerink and Haan 2001, Wehner 2010).

Fiscal discipline can also be influenced by the political orientation of the governing party, with the conventional wisdom suggesting left-oriented governments tend to generate greater deficits than right-wing ones. However, this conventional wisdom has been questioned theoretically and it is not backed empirically (Eslava 2011). Indeed, in the aftermath of the euro area crisis, governments’ degree of parliamentary support or their political orientation is not a good predictor of the size or composition of fiscal consolidation (Kickert and Randma-Liiv 2017).

Fiscal rules and independent fiscal institutions (IFIs) stand out as another potential lever for achieving fiscal sustainability. Relying solely on fiscal rules to achieve financial responsibility quickly became discredited, particularly in the euro area (Wyplosz 2012). The rationale in favour of IFIs appears to be more convincing: they constrain politicians’ fiscal discretion (and the associated deficit biases) while allowing for timely responses to unforeseen events (Beetsma and Debrun 2018). However, it is also clear that IFIs differ greatly across countries in size, remit, human resources, and the circumstances in which they were created (von Trapp and Nicol 2018). It is therefore likely that the impact of IFIs on budgetary discipline varies significantly across countries.

All in all, this literature has uncovered some mechanisms that generate fiscal discipline. However, these mechanisms work properly only in certain conditions, periods of time, or for certain countries. 

From this perspective, and based on a recent paper (Kasperskaya and Xifré 2020), this column proposes an additional factor – complementary to the previous ones – that may help account for fiscal discipline. We advance the hypothesis that some properties of the budgetary framework facilitate the exercise of analytical, or technical, capabilities. Such analytical capacity allows better management of data and information, resulting in improved collective decision making in the public sector. In this respect, this hypothesis is aligned with the literature that emphasises the interrelated nature of the budgetary elements that are conducive to fiscal responsibility: “Fiscal discipline does not emanate from institutions void of intentional decision makers. (…) Fiscal discipline is produced by fiscally tight decision makers, endowed with institutional power to act upon their preferences, and equipped with adequate knowledge of the fiscal consequences that follow from actions” (Helland 2000: 107).

Budgetary analytical capacities

Building from the policy capacity literature (Howlett et al. 2014, Newman et al. 2017), budgetary analytical capacities (BAC) are defined as the set of procedures, mechanisms, and institutions needed for improving policy capacity in the budgetary decision-making domain. Namely, we focus on those capacities regarding the access, processing, and transmission of budgetary information that contribute to good government performance. For this reason, we propose to measure BAC with three attributes, or principles, of the budgetary setup: reliability of the projections, openness to scrutiny, and transparency. 

These principles are considered because each one plays an important role in the stages of the budget cycle in which the management of data and information is a key function: (i) setting the projections that determine the budget aggregates, (ii) the information and scrutiny conditions that are given to the legislature prior to the approval of the budget, (iii) and the proper communication of budgetary information to the wider public. 

Each principle is particularly relevant for capturing the analytical capacity of a distinct policy agent in the budgetary process: central government, legislature, and the wider public (citizens, investors, supranational organisations, think tanks, etc.) respectively. 

The BAC index

Our sample covers the euro area countries that are members of the OECD for the period 2012 to 2016. 

Variables are taken from the OECD Survey of Budget Practices and Procedures conducted in 2012 (OECD 2012). Forty-six individual variables from the survey have been included to cover the three principles: 18 variables for reliability and 14 for both scrutiny and transparency. These individual variables are aggregated into seven factors, resulting in three factors for reliability, three factors for scrutiny, and one factor for transparency. All seven factors have been normalised on a scale of 0 to 1 (following the methodology of Alesina et al. 1999). The score of each dimension corresponds to the average value of its factors, and the BAC index is the sum of the three factors and therefore is on a scale of 0 to 3. Figure 1 shows the value of the BAC index for the 15 countries considered in our sample as well as the contributions of the three dimensions.

Figure 1 The value of the Budgetary Analytical Capacity (BAC) index and its components 

Fiscal discipline and budgetary analytical capacity in the euro area 2

Source: Kasperskaya and Xifré (2020).

Discussion

A complete discussion of the reasons why each individual country gets its BAC score is outside the scope of the present column. One could argue that countries heavily affected by the 2008 crisis changed their budget procedures in the aftermath of the crisis in order to improve their fiscal performance, while the rest of the countries did not. If that were the case, one could not make direct comparisons across all countries in our sample because some would be reacting to an exogenous event and others would not. For instance, it is natural to question whether the score of Portugal (a country heavily affected by the crisis with a relatively good BAC score in 2012) would be maintained if computed with data from the previous release of the OECD budget survey in 2007. A similar concern could apply to Ireland. Unfortunately, it is not possible to compute the BAC scores from the 2007 OECD survey data since the majority of questions have changed between 2007 and 2012. Considering only the common questions in both surveys, three countries affected by the crisis (Portugal, Ireland, and Spain) keep virtually the same ranking and only one (Greece) was in a better position in 2012 than in 2007.

To examine the reliability of the index, we produce an estimate of the countries’ fiscal discipline based on the negative relationship between GDP growth and the debt-to-GDP ratio (Checherita-Westphal and Rother 2012, Panizza and Presbitero 2014). For the period 2012-2016, we regress the variation of debt-to-GDP ratio against the average growth rate of the GDP (under two specifications: one that includes the level of debt in 2012 as an explanatory variable and the other that does not) and we obtain the residuals of the regression. These residuals are a measure of the fiscal discipline of the country in relative terms to the other countries after controlling for the cyclical position of the economy. The correlation between this measure of fiscal discipline and the BAC index is positive and highly significant in both specifications (and stronger for the specification that includes the level of debt in 2012).

In order to rule out the hypothesis that fiscal discipline is primarily driven by political-economy determinants, we compute the correlation between the measure of fiscal discipline and three conventional political-governmental variables from the Comparative Political Data Set (the parliamentary seat share of the parties in the government, cabinet posts share of social democratic and other left-wing parties, and cabinet posts share of right-wing parties). Correlations between political variables and fiscal discipline measures are not statistically significant. 

We conclude that, controlling for the economic cycle, the BAC index is positively associated with fiscal discipline. The association is stronger for the composite index than for the three separate pillars, which is suggestive of complementarity effects among them. Budgetary policymakers could therefore improve fiscal discipline by enhancing the three pillars – reliability of projections, openness to scrutiny, and transparency – that support the BAC.

References

Alesina, A, S Ardagna and F Trebbi (2006), “Who adjusts and when? The Political Economy of Reforms”, NBER Working Paper Series 12049.

Alesina, A and R Perotti (1999), “Budget deficits and budget institutions”, In J M Poterba and J von Hagen (eds.), Fiscal institutions and Fiscal Performance, University of Chicago Press, 13–36.

Baldwin, R and B Weder di Mauro (2020), Mitigating the Covid Economic Crisis: Act Fast and Do Whatever It Takes, a VoxEU.org eBook, CEPR Press.

Beetsma, R and X Debrun (2018), “Independent fiscal councils and the conduct of fiscal policy: Insights from a new eBook”, VoxEU.org, 29 January.

Checherita-Westphal, C and P Rother (2012), “The impact of high government debt on economic growth and its channels: an empirical investigation for the euro area”, European Economic Review 56(7): 1392-1405.

Cheibub, J A (2006), “Presidentialism , Electoral Identifiability, and Budget Balances in Democratic Systems”, The American Political Science Review 100(3): 353–368.

Eslava, M (2011), “The political economy of fiscal deficits: a survey”, Journal of Economic Surveys 25(4): 645-673.

Fatás, A and I Mihov (2010), “Fiscal policy at a crossroads: The need for constrained discretion”, VoxEU.org, 17 June.

Helland, L (2000), “Fiscal constitutions, fiscal preferences, information and deficits: an evaluation of 13 west-European countries 1978-95”, In R Strauch and J von Hagen (eds.), Institutions, Politics and Fiscal Policy, ZEI Studies in European Economics and Law, Vol. 2, Boston, MA: Springer.

Howlett, M, S L Tan, A Migone, A Wellstead and B Evans (2014), “The distribution of analytical techniques in policy advisory systems: policy formulation and the tools of policy appraisal”, Public Policy and Administration 29(4): 271-291.

Kasperskaya, Y and R Xifré (2020), “Analytical capacity in budgetary administrations: the case of the euro area”, Journal of Public Budgeting, Accounting & Financial Management (in press).

Kickert, W and T Randma-Liiv (2017), “The politics of cutback management in thirteen European countries: statistical evidence on causes and effects”, Public Management Review 19(2): 175-193.

Newman, J, A Cherney and B W Head (2017), “Policy capacity and evidence-based policy in the public service”, Public Management Review 19(2): 157-174.

OECD (2012), OECD Budget Practices and Procedures Survey, Paris: OECD.

Panizza, U and A F Presbitero (2014), “Public debt and economic growth: is there a causal effect?”, Journal of Macroeconomics 41: 21-41.

Perotti, R and Y Kontopoulos (2002), “Fragmented fiscal policy”, Journal of Public Economics 86(2): 191–222.

Persson, T and G E Tabellini (2003), The economic effects of constitutions, MIT Press.

Volkerink, B and J D Haan (2001), “Fragmented government effects on fiscal policy: new evidence”, Public Choice 109: 221-242.

von Trapp, L and S Nicol (2018), “Measuring IFI independence: a first Pass using the OECD IFI Database”, In R Beetsma and X Debrun (eds.), Independent Fiscal Councils: Watchdogs or Lapdogs? London: CEPR Press, pp. 47-64.

Wehner, J (2010), “Cabinet structure and fiscal policy outcomes”, European Journal of Political Research 49(5): 631–653.

Wyplosz, C (2010), ”Eurozone reform: Not yet fiscal discipline, but a good start”, VoxEU.org, 4 October.

Wyplosz, C (2012), “Fiscal rules: theoretical issues and historical experiences”, NBER Working Paper Series 17884.

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