A few years ago, I was asked to co-author a chapter on fiscal federalism and public financial management (PFM) together with my friend and colleague, Professor Roy Kelly. Even though the topic addressed by the chapter is inherently technical, the underlying “moral of the story” was rather non-technical, yet highly relevant for PFM experts working in rapidly decentralizing countries.
The crux of our argument—which is critical to understand in order to ensure a successful transition to an effectively decentralized state—is that there is a big clash in cultures between PFM experts and decentralized governance specialists:
On one hand, the bane of the existence of an international PFM expert is to introduce and strengthen integrated financial management systems, treasury management systems and increasingly advanced financial management techniques for Ministries of Finance around the world. As such, PFM specialists take pride in pursuing highly advanced technical approaches—such as the introduction of highly specialized computerized financial management tools, detailed budgeting processes and increasingly sophisticated Charts of Account and accounting standards—in order to ensure that the Ministry of Finance has as much centralized control and oversight over public sector finances as possible.
On the other hand, the main purpose of decentralized governance is to reduce the centralized control of the central government—including the Ministry of Finance—and to entrust a greater share of planning, budgeting and operations to local governments that—by definition—will never have the same level of technical specialization in area of public financial management as the Ministry of Finance. As such, the critical element of (fiscal) decentralization is to reduce the ability of the central government to control subnational public finances.
If this cultural clash gets ignored, and if the decentralization tribe and the PFM tribe are not able to see each other’s perspectives, it is highly that one of two undesirable scenarios will unfold:
The first undesirable scenario is that the sound advice of PFM experts is ignored, and local governments are effectively left to their own devices when it comes to planning, budgeting, financial management, reporting and audit. Even in the absence of clear standards and systems, some local governments—particularly those with a larger economic base, more active civil society and with greater access to technical expertise—will introduce more-or-less sound financial management practices. However, in the absence of clear and appropriate standards and systems, sound financial management practices will not emerge in the vast majority of local governments.
Because under this scenario, local governments lack the necessary financial management standards and systems, it becomes virtually impossible for local governments to provide regular, detailed financial report to their constituents, local assembly, and to higher government levels. As a result, there is no accurate information on how much is spent at the local level on capital infrastructure versus wages or operation-and-maintenance spending; there is no accurate information on whether local funding is provided to operate primary schools or local health facilities services, versus resources being spent on local administration or on allowances for local officials. In the absence of even the most basic, consistent and reliable information on revenue and spending from all local governments, local constituents cannot hold their local officials accountable and national government lacks the necessary fiscal information to promote national policy objectives through the management of intergovernmental finances.
The second scenario, however, is equally undesirable. Under this scenario, national PFM experts are given free rein to develop and impose PFM standards and systems for local governments—but without heeding the caution from their decentralization colleagues about the more limited institutional capacity of emerging local governments. As local governments are now assigned many important sectoral responsibilities, PFM experts—in line with the culture of their tribe—develop detailed local PFM rules that borrow heavily from existing central planning, budgeting and financial management processes, so that all local governments follow the highest PFM standards. This may include requiring local governments to prepare the budgets in great detail for different sectoral programs and activities; by requiring local governments to prepare medium-term financial frameworks; the imposition of an advanced computerized IFMS; or efforts by the central government to manage conditional grants in a highly earmarked manner.
Given the realities on the ground, however, this approach to subnational PFM is equally likely to fail as the first scenario, as best-practice national PFM systems are not fit-for-purpose at the local government level, and as the gap between the institutional requirements for implementing such advanced PFM systems and the institutional realities on the ground are simply too large. As a result, while a handful of the largest local governments may be able to live up to these standards, the vast majority of local governments will quickly abandon this effort and return to whatever system is most suitable given their limited institutional capacity.
Because local governments are not able to apply the advanced financial management standards or systems as intended, it becomes virtually impossible for local governments to provide regular, detailed financial report to their constituents, local assembly, and to higher government levels. As a result, there is no accurate information on how much is spent at the local level on capital infrastructure versus wages or operation-and-maintenance spending; there is no accurate information on whether local funding is provided to operate primary schools or local health facilities services, versus resources being spent on local administration or allowances for local officials. In the absence of even the most basic, consistent and reliable information on revenue and spending from all local governments, local constituents cannot hold their local officials accountable and national government lacks the necessary fiscal information to promote national policy objectives through the management of intergovernmental finances.
So, what is the solution to achieving sound public financial management at the subnational level in a rapidly decentralizing country?
The solution begins by recognizing that neither PFM experts nor local governance specialists can answer the challenge of local PFM by themselves, and that a meeting of the minds between these two tribes is required. In the end, the solution comes down to realizing that the PFM needs of local governments are—by their very nature—not the same as central governments, and that there is not a “one size fits all” solution to subnational PFM. Instead, in order to make sure that the intergovernmental finance system as a whole can function in the context a decentralizing state, the most urgent need is to define the most advanced PFM system that can be plausibly implemented by the weakest local government in the country today. This local PFM system—whether manual, Excel-based or fully computerized—will by definition form the lowest common denominator for subnational PFM systems and ought to form the basis for local financial reporting requirements and for the management of the intergovernmental fiscal system as a whole.
The metrics of success for a successful local PFM system are not defined by how advanced the system is, but rather by (i) whether all local governments are able to manage their books of account in accordance with the minimum local PFM standards, and (ii) the national government is successfully able to collect and publish consolidated local government finance reports for all local governments on a quarterly basis. In fact, efforts to implement more advanced local PFM systems should not be considered a priority until all local governments in a country have a minimally effective PFM system in place and regularly report on their revenue and expenditures.
Once a minimally effective local PFM and financial reporting system is in place, strengthening subnational PFM and intergovernmental financial management systems can proceed along two prongs. First, support can be given to larger and more advanced local governments to implement financial management tools and practices that exceed the minimum standards. Second, institutional strengthening support can be given to the weakest local governments so that they can introduce increasingly advanced PFM systems and practices, which would gradually raise the minimum standards for the local PFM system as a whole.