This chapter explains what is necessary to implement public financial management and internal control (PFM/IC). It discusses the role of parliament, how the different elements of PFM/IC can be achieved including what sound financial management means, what are cost drivers and cost centres and why such information is required by managers. It explains why there is a need to ‘professionalise’ management and the difficulties with doing so. It discusses briefly the role of the head of finance and the arrangements for the control of second-level organisations. It also considers how to achieve the benefits of the reform. This chapter expands on the argument introduced in Chap. 1 that the reform is not simply achieved by introducing a series of bureaucratic reforms based upon international standards. Management is of the essence and without good quality management the benefits will not be achieved. However, achieving the reform will not be easy and potential difficulties are identified and discussed.

2.1 The Context for Public Financial Management and Internal Control (PFM/IC)

The regulatory framework governing PFM/IC should be specified in a law or set of laws and other regulations approved by a country’s parliament. The powers and duties of the different bodies involved in the processes of PFM/IC should prescribe how income is to be raised through taxation and other means and how public organisations are to utilise the resources made available to them. The law and the complementary regulations should be transparent and their application predictable. This is so that those involved in the processes are clear in their responsibilities, that there is a consistency of approach and that civil society can comment on the political and managerial decisions that are made in the utilisation of public resources. The budget, which is the core financial document, will be developed by the ministry of finance and approved by the cabinet of ministers. It will represent government policy. Parliament should want to approve the allocation of resources and decisions about the raising of taxation and other revenues. It would do this through the approval of the budget which will then be enacted in a budget law. Parliament may establish a committee (e.g. a budget committee) to undertake detailed scrutiny of the budget proposals. At the end of the financial year, the parliament should also approve or not how resources have actually been spent during the year and in addition should have a view about how well that money has been spent. It may do this in three ways, one through the consideration of periodic expenditure statements submitted by the minister of finance including proposals for variations to the budget (‘virement’), secondly through consideration of the report of the state auditor via the establishment of a public accounts/audit committee (or equivalent) and thirdly through scrutiny of the quality of public expenditure in some detail via the establishment of a special committee. Exactly how parliament would undertake these specific responsibilities would depend upon the arrangements applying in a particular country. For example, it may wish to approve all changes to the budgetary allocations or only the more significant ones. In some countries parliament may establish committees with the specific responsibility of reviewing public expenditure by different ministries.

In principle, this is no different from the traditional budgetary framework. However, with PFM/IC the content will be different.

PFM/IC creates the opportunity for greater parliamentary scrutiny and accountability because the budgetary arrangements ought to have a focus upon outputs as well as inputs. Traditionally the scrutiny role of parliament has been to review what has been spent against the approved budget and to approve or not any variations. PFM/IC adds to that scrutiny role by making it possible, because of the additional focus on outputs, for parliament to consider not only how public resources have been spent, but also how well they have been spent and whether objectives have been achieved and performance standards maintained. Parliament may be advised in this process of review by the state auditor. Parliament could do this by holding either the government itself or individual ministers to account on whether they have achieved the objectives and performance standards set out in the budget or indirectly through its use of the type of committee referred to above. An indicator of the strength of the parliamentary processes should be the existence of specific arrangements within parliament to review the effectiveness of the PFM/IC arrangements. A key figure in this review process should be the state auditor. The state auditor role should include ensuring that governmental activities are carried out in a manner consistent with parliament’s intentions, and are effective, efficient and economical. The existence of a budget focussed upon outputs as well as inputs facilitates the development of this role.

Consequently, parliament should approve the laws and regulations relating to the introduction and development of this reform. Parliament should be consulted by the government about the policy of implementation and on progress during the application of the reform. As PFM/IC creates new opportunities for parliament to assess the quality of public expenditure, parliament should be concerned about the arrangements for the reporting of the activities of government and the quality of its performance. With PFM/IC as parliament is able to move from a simplistic concern for spending to a more complex concern for what public resources have achieved or not achieved, that is, both ‘inputs’ and ‘outputs’. This provides greater opportunity to hold government to account and also individual ministries. (Chap. 13 discusses the form of reporting and the information that the report should contain.)

The ministry of finance will be the key ministry that parliament should relate to over the establishment of PFM/IC. This ministry should provide reports to parliament on the development of the PFM/IC policy and on its application within government organisations. Parliament should hold the ministry of finance to account for progress (or lack of it). This accountability process should act as a driver of the reform. The effectiveness of the PFM/IC reform should be reflected in the achievement by the government and, by extension, by individual ministries, of the approved policies, and objectives. Therefore, the focus of accountability is extended. Parliament should also be in a better position to ask questions about the efficiency and effectiveness of public expenditure and the economical use of public resources. Traditional public financial administration arrangements would not achieve these accountability benefits.

The conclusion is that PFM/IC can only be applied effectively if a functioning parliament exists. Parliament has an important role in the processes of implementing PFM/IC and in the complementary accountability processes. A functioning parliament is one that gives the public voice, ensures transparency, and has the capacity to effectively challenge the government through an accountability process. Political stability in the country should also be an important feature prior to the implementation of PFM/IC. Political stability is about the integrity and durability of the government structures. It does not mean that there can be no change of government rather that a change of government does not result in such an inconsistency of policy that long-term reform (such as PFM/IC) cannot be implemented, that political consensus about the significance of the reform cannot be achieved and, in the example of PFM/IC, that the ministry of finance and its political leadership is unable to consistently focus upon the reform. Political instability may also be evidenced by social unrest which distracts policy makers from effective consideration of managerial issues.

2.2 Implementing PFM/IC Reform

Public financial management as a discipline consists of two main areas of activity covering all the components of a country’s budget process. One is ‘upstream’ (including strategic economic planning, the development of medium-term expenditure frameworks, and annual budgeting): the other is ‘downstream’ including expenditure management to deliver services and activities efficiently and effectively, to ensure that assets are fully and properly utilised, that all resources are only used for approved public purposes, that revenues due to public organisations are managed efficiently and that procurement, control, accounting, reporting, monitoring and evaluation, audit and oversight are effective.Footnote 1 This guide focusses on the ‘downstream’ element of public financial management recognising that there is an overlap with the budget making process. (The quality of annual and medium-term budgeting arrangements significantly affects the quality of the ‘downstream’ activities.)

Public financial management covering both upstream and downstream activity has become by far the most common theme of public sector finance related reforms. A reason for this lies in the increasing use of budget support funding by aid agencies with their corresponding concern to ensure that such funding is not abused. As noted in Chap. 1, whilst countries may themselves initiate their own reform to implement PFM/IC, very often the initiative comes from third parties such as multi- and bilateral organisations as a condition for the granting of budget support funding. Budget support funding involves the transfer of funds directly to a country’s own treasury and therefore relies on the strength and capacity of a country’s own systems to ensure that funds are used for the agreed purposes and that they are used efficiently and effectively. Budget support funding, despite its advantages, does expose donor countries to greater risks of waste, fraud, and corruption and, as a result, there is a greater emphasis on countries to address these problems.

When countries make the decision to adopt the PFM/IC reform unfortunately much of the advice that they receive from bi-and multilateral agencies is driven by the conditions attached to budget support. Very often this is based upon ‘form’ not ‘substance’, with short time-scales. Also, such advice may not be suited to the local bureaucratic and cultural context. Consequently, the focus in such circumstances is on developing and implementing the laws, systems, and accompanying bureaucracy that needs to be in place rather than considering the broader issues such as the human or managerial consequences. Those laws and systems are usually defined to represent international best practice which as was pointed out in Chap. 1 may be completely irrelevant to local needs. This is because a country may not have the governance, managerial capabilities, information or disciplinary structures, and skills that are necessary to ensure that international best practice provides a workable solution. There also may be inconsistencies with local cultural traditions. (The experience of this author is that, despite these problems, aid agency pressure tends to be to encourage countries to adopt advanced practice such as PFM/IC, based upon the idea that ‘international best practice’ represents the most appropriate solution rather than recognising that, as in this example, ensuring initially that PFA/IC is robust and that a managerial capability exists before proceeding with the more advanced reform.)

2.3 Who Is the Manager?

Because PFM/IC is as much a management reform as a technical financial reform, the question that then arises is ‘who is the manager’ and what are his/her responsibilities. This was discussed in Chap. 1 where the point was made that in some countries all management responsibilities covering policy and strategy development, policy execution and all other aspects of operational managementFootnote 2 are the responsibility of politicians or politically appointed officials. In other countries, with more developed arrangements, a distinction is drawn between the responsibilities of politicians including other politically appointed officials, who are responsible for policy and strategy development and oversight of policy execution, with operational management including policy execution, being the responsibility of civil servants and local government officials.

As has been explained previously, with PFM/IC in each public organisation there should be an official appointed with overall responsibility for the quality of operational management. This would include responsibility for the development of the organisational structure with managers appointed at different levels in the organisation. In some countries a state secretary (or equivalent) would have the authority to make the decisions about the management structure whilst in others agreement with the minister or other politically appointed official may be necessary. With the introduction of PFM/IC the state secretary (or equivalent) has a central role because he/she should also be responsible for the practical application of the PFM/IC policy and its ongoing quality, including the efficiency and effectiveness with which public resources are utilised.

It was also pointed out in Chap. 1 that ‘management’ requires the making of judgements and all judgements require the acceptance by the decision maker of some degree of risk. Accepting the need for risk taking will be new to many civil servants and local government officials where operational management responsibility is to be delegated to them from politically appointed officials as part of the PFM/IC reform. This could well cause them to resist the changes that the reform entails. Yet central to the reform is delegation and managerial accountability. The ‘upside’ to this for these officials is a more effective operational role coupled with better quality decision making. For elected officials this removes from them many administrative responsibilities, some of which can be quite trivial, and gives them time to focus on their primary responsibilities of policy development, strategy, and monitoring. However, in many countries with traditional legally based public financial administration and internal control arrangements (PFA/IC) civil service rules or laws can inhibit initiative and threaten civil servants with penalties if they make mistakes or errors of judgement. Financial inspection arrangements can also discourage risk taking. In many developing and transition economy countries even the most senior officials in line ministries have limited authority to make decisions, not because of political constraints but because approval has to be sought from central ministries. And in those central ministries  the responsibility for approving a line ministry decision often lies with a lower level official. So in effect who is the manager? Is it the official in the line ministry or the official in a central ministry giving the approval?

Before the introduction of PFM/IC, as explained in Chap. 1, the ministry of finance should satisfy itself that a robust PFA/IC exists (see Chap. 3 for a detailed explanation of the differences between PFM/IC and PFA/IC). The focus with PFA/IC is upon control and compliance, rather than on the achievement of objectives efficiently and effectively, to time and to standard as well as within budget. Control and compliance are critical attributes which all countries ought to strive to attain and they should be maintained with the introduction of PFM/IC. If control and compliance do not exist, a sophisticated system is being introduced without the underpinning basic financial stability and without recognition and acceptance of the structures necessary to achieve and maintain that stability. This is the equivalent to building a physical structure on sand, that is, without appropriate foundations: a structure which will be unable to withstand the buffeting of events.

2.4 Efficiency and Effectiveness and PFM/IC Reform—Why Countries Should Want to Introduce the Reform

2.4.1 Securing Efficiency and Effectiveness

Most governments, taxpayers, service users and external development partners (i.e. bilateral and multilateral agencies) want efficient and effective arrangements for the raising of public revenues and for the utilisation of public financial resources. Introducing PFM/IC is a core strategy to help achieve this aim. ‘Efficiency and effectiveness’ were defined in Chap. 1 by referring to a definition attributed to Peter Drucker, that is, efficiency is doing things right; effectiveness is doing the right thing. Doing the right thing depends upon the quality of the policy determining what services are to be delivered and how they are to be delivered. However, achieving efficiency and effectiveness in practice is not at all easy and whether it can be achieved depends very heavily upon the quality of the policy operational management is required to implement. The changes required to achieve efficiency and effectiveness, for most, if not all, developing and transition economy countries will require significant management and financial reform, a reform to the control framework exercised by bodies external to a ministry or local government such as the ministry of finance and the ministry responsible for personnel management, as well as to budgetary and financial information arrangements. It will also require the existence of focussed pressure to achieve improved utilisation of resources and that pressure may be generated by the ministry of finance through the budgetary process, or directly by the political and/or operational leadership of a ministry or other public organisation. Once that pressure is established the leadership of the operational management (the state secretary or equivalent) and the head of finance should have a specific responsibility to identify inefficient and ineffective operational activity whether it be in the raising of revenues or in public expenditure. Each individual manager should also have a responsibility to achieve efficiency and effectiveness in delivering the services or activities for which they are responsible.

To develop a policy that will facilitate efficiency and effectiveness both the political officials and the operational manager (i.e. the civil servant or local government official) need to be involved. The former should set the policy based upon the political agenda of the government which should be developed in consultation with the operational management. (The operational manager should be able to advise, based upon experience, on the practicalities of implementing policy.) Efficiency and effectiveness are not simply about compliance with laws, regulations and policies and budgets or just spending less money, although they can include all of these attributes. Efficiency is about producing the results intended (i.e. the objectives and performance standards) and doing so in a manner which maximises those results for the least input of resources, both current resources, such as personnel and supplies, and services and investment resources, such as assets. Effectiveness is about results being those that the user of the service or activity requires or which meets their needs and does so to time and standard, rather than the results that the supplier wishes to produce. Effectiveness can only be established by identifying the impact of the activity, including asking the user. The user may be external to the organisation or internal. However, consultation with the user is an important dimension in improving the quality of public service provision. Sometimes, however, the results can be perverse and managers need to be alive to such a risk. For example, a drug prevention scheme in the USA probably increased marijuana use.Footnote 3

To achieve efficiency and effectiveness, the manager needs discretion and that is why the traditional framework of external controls needs to change.

However, not all countries want a focus on efficiency and effectiveness with policy being more concerned with maximising public sector employment. Where this is the situation, such countries should concentrate on improving the quality of PFA/IC rather than seeking to adopt PFM/IC.

2.4.2 The Role of the Operational Manager in Achieving Efficiency and Effectiveness

Although the terms ‘efficiency and effectiveness’ have become widely used in the processes of public financial management reform there is no ‘automatic’ driver as in the private sector, where the market ultimately forces in efficient and effective management of resources. In the public sector the driver has to be political coupled with managerial initiative, ultimately driven by political debate and end user reaction (i.e. through accountability).

To deliver operational efficiency and effectiveness as the manager needs discretion this requires the delegation of authority from the politician. Another factor affecting discretion is the extent to which the manager is subject to detailed control by an external organisation. Where that occurs (e.g. by a ministry of finance or the organisation responsible for personnel management), achieving operational efficiency and effectiveness can become impossible.

Compared with the private sector achieving efficiency and effectiveness in the public sector context is much more complex. In the private sector products and services are relatively easily identifiable and a supplier, for example, does not have to supply every potential customer. In the public sector products and services can be less easy to define. Thus, what are the specific objectives of ‘education’ or ‘security’? Also, very often the public sector supplier cannot choose who to supply or not supply. Again, in the public sector if the terms efficiency and effectiveness are to have any real meaning, managers need not only discretion but require operational objectives and providing clarity of objectives can be difficult. Changes are also required to traditional methods of public sector working. For example, a manager requires different financial information than a ministry of finance requires for budgetary and financial control purposes, although a manager needs that as well for the manager's specific area of responsibility. To facilitate effective management the finance made available through the budget should be linked to objectives and performance standards including performance objectives. This then makes it possible for the operational manager, provided that manager has agreed that the budget and objectives and performance standards and objectives are compatible, to deliver objectives and performance within budgetary constraints and to be held accountable for doing so. To achieve management discipline in this context the operational manager needs to be under systematic pressure from his/her superior manager, who ultimately may be a politician.

2.5 Defining ‘Sound Financial Management’

2.5.1 Sound Financial Management

An aim of the PFM/IC reform is to give ‘reasonable assurance’ that a public organisation’s transactions comply with the principles of ‘sound financial management’, that is, ‘transparency, efficiency, effectiveness, and economy, as well as with relevant legislation and budget descriptions’.Footnote 4 Sound financial management therefore means much more than a traditional approach to internal control which is focussed on legality and financial and budgetary control. Financial management encompasses all the activities within an organisation that are concerned with the raising and use of resources designed to achieve the objectives of the organisation efficiently and effectively:

Financial management is a core part of successful management, central to each organisation’s decision-making process and an essential part of the overall performance management. It is essential to the effective corporate governance of an organisation and fundamental to achieving objectives. High performing organisations and those with a track record of improving services consistently demonstrate strengths in leadership, performance management and financial management.

Financial management encompasses all the activities within an organisation that are concerned with the use of resources and that have a financial impact. CIPFA has defined financial management for public bodies as the system by which the financial aspects of a public body’s business are directed and controlled to support the delivery of the organisation’s goals.

The financial management arrangements within public sector organisations provide information that management use to:

  • Direct the activities of the organisation

  • Control the activities of the organisation

  • Report and discharge accountability

  • Utilise resources efficiently and effectively.Footnote 5

Therefore, in the context of financial management, ‘internal control’ has a much wider application than simply the traditional transactional approach to financial and budgetary control envisaged in the context of PFA/IC. It includes those controls that are necessary to ensure that the management delivers the objectives and performance within the law and any budgetary constraints, efficiently and effectively. Those controls need to be defined and made operationally effective.

The idea of the discharge of accountability is not one that is confined to internal accountability but incorporates external accountability to the user of services and their representative groups, to parliament and to the taxpayer. In other words, PFM/IC also involves a greater degree of transparency and accountability than traditional administrative systems.

2.5.2 Financial Control

Financial management incorporates ‘financial control’. Financial control is designed to ensure that the operational managers of the organisation, at all levels, follow in practice the rules and regulations about all financial matters (usually set out in ‘financial regulations’) including the safeguarding of assets. Financial management also incorporates ‘budgetary control’ which requires that the operational managers ensure that budgets are not overspent or overcommitted and are only used for the purposes for which those budgets are intended, or that where income is to be generated that income forecasts are achieved.

Financial management within a particular area is the responsibility of the manager for that area although the organisation’s head of finance should be involved in this as a provider of key information and as an adviser to the manager.

2.5.3 Cost Drivers and Cost Centres

To achieve ‘sound financial management’, as has been indicated above, operational objectives and performance standards need to be defined and linked to the policy and budgetary objectives a manager is expected to achieve. This means that the traditional process of developing a budget by taking the previous year, adding for inflation, and then adjusting the total to reflect economic forecasts, will no longer be appropriate. If a budget is to have any meaning in managerial terms it must be linked to policy objectives and to performance standards. This is what a change to PFM/IC ultimately requires. Those policy objectives in many circumstances will also be ‘cost drivers’. A cost driver is a factor that affects the level of costs that an organisation is likely to incur and therefore how policy impacts on the budget. Examples of cost drivers can be quite simple such as the policy towards the numbers of children to be educated, or elderly persons to be cared for by the state or total numbers of persons held in prisons or the number of children to be vaccinated. But they can be more complex and may depend heavily upon the complexity of the policy being pursued or they could be a combination of both simple and complex cost drivers. For example, the number of crimes, depending upon their type, can affect the demand for police resources but how the police and the judicial system address the consequences of criminal activity will affect the total budget that is needed. In effect a cost driver can be a particular political or management policy or it can be a numerical factor such as the pupil/teacher ratio. Changing the cost driver can significantly affect costs. Another example would be penal policy, where the policy approach to sentencing affecting the length of prison sentences for different types of crime can have a material impact on costs. Or again it could be the age at which children are vaccinated and the range of vaccinations to be provided. If costs are to be kept under control regard should be had to such cost drivers.

Identification of cost drivers and associated costs is an important factor in the establishing quality in the policy making process.

The operational manager needs to be able to allocate costs over different areas of activity, that is, over cost centres. A cost centre could be a regional office or prison, or police unit or operating theatre, or university course and so on. The manager will also need to know the level of the operational performance of each cost centre. Some cost centres will operate more efficiently than others and the manager must know this. Only then is the manager able to take any necessary corrective action. That action may include changing the cost centre manager or its staffing or reorganising the cost centre organisational arrangements to reflect changes in demand for its services. To make such a detailed allocation of costs possible more elaborate coding of costs and more detailed information about performance will be required.

Making operational decisions based upon cost driver and cost centre information should be the responsibility of the operational manager. To support the manager the head of finance should be able to provide the information the manager needs to identify which cost drivers to address, and which cost centres require his attention if costs are to be kept under control and efficiency improved. The operational manager should inform the policy maker where the cost driver is having effects upon budgetary limitations, and the policy maker should then decide on any action to be taken. Cost drivers are highly significant in translating policy ideas into practical and operationally effective public services. There is a legitimate question about whether particular policies, or the methods of delivering those policies, result in the efficient and effective utilisation of public resources. (Poor policy formulation can be a cause of inefficient and ineffective public services.) Cost centre analysis is about efficiency and effectiveness and whilst operational management should be the responsibility of the civil service or local government manager the reorganisation or sometimes closure of cost centres may require political authority.

Overall, with ‘sound financial management’ developed through the adoption of PFM/IC objectives and performance standards will be more likely to be achieved than would occur with traditional systems of financial and budgetary control which focus simply upon financial parameters.

2.6 Appreciating the ‘Management’ in Public Financial Management

2.6.1 The Professionalisation of ‘Management’

Public financial management when considered from a ‘downstream’ perspective is based, as the name implies, upon the idea of management. Public financial management is not simply a collection of technical tools (i.e. application of international standards, laws, and systems with associated training) that if implemented will, of themselves achieve a range of benefits leading ultimately to economic improvement. Much more is required. In particular ‘managerial professionalism’ is needed. Professionalism refers to the behaviour, attitude, competence, accountability, and integrity standards expected of managers and impacts upon how they undertake their responsibilities, including the exercise of leadership within their organisation and accountability for their organisation’s performance. ‘A state that promotes management promotes professionalism—discretion, performance and stewardship.’Footnote 6

The European Union in its advocacy of public financial management reform has recognised this. A key feature of the public financial management reform it requires to be undertaken includes the development of managerial structures accompanied by appropriate delegation and managerial accountability. This means:

  • First, the delegation from the political level of management of the responsibility for most operational management decisions for the delivery of public services and activities, to the civil or local government service but within the approved policy and strategic political context; and

  • Second, the establishment of operational managerial accountability ultimately back to the political level of management.

In other words what is required in practice is that to achieve effective PFM/IC there does need to be a separation of responsibility for policy and strategy development from operational management, the former being a political responsibility and the latter a civil or local government service responsibility. However, effective policy making does depend upon close cooperation between the operational manager and the policy maker with the former advising the latter on the feasibility and cost of policy. This also has an impact upon budgetary, financial and performance information arrangements (these are discussed in Chaps. 5 and 8) as well as upon decision making processes and how the responsibilities for control are exercised.

The introduction of PFM/IC with the professionalisation of management also imposes significant additional technical responsibilities upon the manager which would make very difficult the combination of policy and strategy development with operational management. In that event the likelihood would be that one or other would not be properly undertaken.

However, as has been commented upon previously, in some transitional and developing economy countries, even though they may nominally be introducing PFM/IC, operational management effectively remains a responsibility of the political level which therefore undertakes the two roles of defining policy and the strategy for its delivery and the operation management of service or activity delivery. Consequently, delegation and managerial accountability between the civil or local government service and the political level are not being achieved. This does not encourage the development of an effective and responsible civil and local government service management or the opportunity for the provision of independent informed advice to political policy makers. It also casts doubt on the quality of both policy development and operational management.

Countries wishing to join the European Union are expected to absorb a managerial dimension into public financial reform from the outset of the reform process. Other countries may not be required, or wish, to undertake the same comprehensive reform as those European influenced countries and therefore may only wish to address the internal controls that lead to an improved quality of public financial administration.Footnote 7

2.6.2 Challenges to Professionalising Management

One problem with developing a professional management is resistance both by the political level and by the official level to this management element of the reform. Also, the public administrative culture may not be compatible with the introduction of advanced PFM reforms as the following report on a regional workshop sponsored by the IMF on the challenges of developing MTEFs and PBB (a similar advanced PFM reform to PFM/IC) in East Africa indicatesFootnote 8:

Participants concluded that regional MTEF and PBB reform objectives are not fully reconciled with the structure, processes, laws, regulations, procedures, practices and capacity in place, hence failing to reap the benefits of these reforms. They also noted that the prevailing public service management culture does not encourage the delegation of responsibility for managing programmes and budgets at the ministry and agency level, or the development of improved decision making within government on the prioritisation and allocation of budgetary resources. The incentives for civil servants to improve performance are quite weak. In addition, improved macro-fiscal forecasting is hampered by weak national statistical databases.

The workshop further concluded that:

‘existing reforms of MTEF and PBB focus too much on the formal technicalities (e.g. developing new reporting templates and elaborate systems of performance indicators) without much consideration of how these techniques and data should be used to improve decision making on the prioritisation and allocation of resources. Ministries and agencies often lack the capacities to analyse performance information, and the new reporting formats and performance data are not fully integrated into existing platforms (IFMIS) for managing financial information. Finally, the Cabinet debate is not informed by the need for improved performance, while parliamentary interest in holding the executive accountable for performance is limited.’

‘Above all, countries should invest in changing the culture and ‘mindset’ of public officials so as to support improvements in the efficiency and effectiveness with which public services are delivered. Key stakeholders should be sensitised to encourage a common understanding and ownership of the MTEF and PBB reforms, and to reduce their resistance to these reforms. Such a programme of change management is not a simple matter and will require leadership and commitment over a sustained period. Borrowing from experiences in more advanced countries, and taking account of the magnitude of the reforms, participants proposed therefore that a phased approach to adopting MTEFs and PBB was more sustainable.’

A second problem is that civil servants and local government officials do not somehow automatically become managers once the title of ‘manager’ is bestowed upon them. Management is a skill which is in short supply, especially in the public sector and particularly in developing and transition economy countries. This means that success with this reform is likely to require a heavy investment in management training, which in turn may require the making of special arrangements with an appropriate training institution such as a university. It will also affect human relations (personnel) policy, the quality of the work that civil servants and local government officials are engaged in, how they are to be incentivised and rewarded (and this is not just about pay) and the training that is to be provided. Political management also needs to show evidence that the skills are valued and that staff are encouraged to develop their skills within government through promotion and other career development opportunities. The same circumstances apply to financial managers. Theirs too is a skill in short supply in the public sector and specific skill training is likely to be required with the same problems as for managers, that is, skill retention, incentives, and rewards. (These topics are discussed more extensively in Chap. 14.)

Bearing in mind the potential for increased accountability, resistance to a reform involving delegation could also exist for other reasons. For example, at the political level it affects opportunities for patronage (including rent seeking), perceived status and requires that a significant degree of trust exists between politically appointed and civil service and local government officials. For the official level, taking decisions involves risk and the possibility of penalties. The civil or local government service may lack trust in the willingness of the politically appointed officials to take their share of the blame if something goes wrong. Given that the ideal civil or local government service should be non-political establishing ‘trust’ can be difficult for both sets of parties.

To achieve the gains from the PFM/IC reform countries need to recognise that managerial reform is essential as a prior condition and that reform should start at the top of organisations, usually at the political level, that is, with the minister or mayor, as the report quoted above demonstrates. This is even though reform at this level can be the hardest to achieve, especially where organisational and management structures are highly hierarchical, where challenge to authority can be very difficult to sustain without adverse consequences, and where a need for delegation of operational management is not recognised.

However, having applied the PFM/IC reform and developed the managerial and financial capacity to support the management the further problem is how to sustain the reform. This depends very heavily upon an ability to retain those skilled managers and financial managers. A political policy that relies on political appointees only to fill senior civil and local government management positions does not help.

2.6.3 Management Structures and Delegation

Exactly what the management structure should be for each organisation will depend upon various factors, including:

  • The size and complexity of the organisation and its objectives.

  • The type(s) of service or activity being delivered.

  • The political sensitivity of the organisation or activity.

  • The confidence of the organisation leadership in the more junior officials (which can involve the relationship between politically appointed officials and the civil or local government service officials).

  • The extent to which an organisation can manage the delivery of its objectives or whether success in delivery depends upon cooperation with other organisations.Footnote 9

  • The financial and other resources which are available.

The effectiveness of a management structure depends upon the clarity of its objectives, performance standards and performance objectives, the powers, the resources (including the information available to the managers at different levels in the organisation), the spans of controlFootnote 10 of different managers, that is, are they relevant for the responsibilities that the manager has? In other words, is the degree of delegation and are the corresponding accountability arrangements for that manager appropriate?

2.7 Internal Control and Management

Internal control has been defined by INTOSAI as follows:

Internal control is an integral process that is effected by an entity’s management and personnel and is designed to address risks and to provide reasonable assurance that in pursuit of the entity’s mission, the following general objectives are being achieved:

  • Executing orderly, ethical, economical, efficient, and effective operations.

  • Fulfilling accountability obligations.

  • Complying with applicable laws and regulations.

  • Safeguarding resources against loss, misuse, and damage.

*Internal control is a dynamic integral process that is continuously adapting to the changes an organisation is facing. Management and personnel at all levels have to be involved in this process to address risks and to provide reasonable assurance of the achievement of the entity’s mission and general objectives.Footnote 11

This definition of internal control emphasises the role of management (note: at all levels, not just at a top and senior level) and that of the mission of the organisation which is about the achievement of the organisation’s objectives (i.e. corporate objectives). A mission cannot be left vague: it must be defined and this means that its objectives need to be clearly identified and as far as possible measurable.Footnote 12 Those objectives also need to be cascaded down to the different levels of management. (In practice to achieve the overall objectives of an organisation, the political objectives may have to be divided over sub-objectives, and sometimes sub-sub-objectives, with a manager being responsible for the delivery of each sub-objective or very often, more than one sub-objective.) Organisational budgets should be linked to those objectives and in practice organisational policy objectives should be supplemented by performance standards, and performance objectives (such as waiting times for accident and emergency patients or the utilisation rates for operating theatres or school examination success rates for pupils, or reduced reoffending rates for prisoners).

Internal control when used in a management context incorporates the INTOSAI definition but should be developed to include not only the controls necessary to secure budgetary compliance and adherence with the law and financial regulations, but also, and very importantly those controls necessary to:

  • Secure the delivery by public service managers of the objectives, performance standards and performance objectives that they are or ought to be expected to deliver.

  • Ensure that public resources, including assets, are used efficiently and effectively.

  • Ensure that public revenues are raised and managed efficiently and effectively.

  • Ensure that the financial resilience of the organisation is maintained over time. (This is not about medium-term budgetary planning, although that is important in this context but is about ensuring that decisions are not made which are likely to be unfinanceable into the future. Considering the financial impacts only over a single year or even a 3-year period in the delivery of public services is, for most such services and the associated activities, far too short a time horizon and does not recognise the level of capital investment usually required to deliver such services or the long lead times necessary to achieve objectives.)

One feature of those controls would be an effective system of risk management. A second would be systems of managerial accountability and how managerial accountability reports are responded to by higher-level management. A third would be the systematic assessment of the effectiveness of public services and activities in achieving their objectives.

Introducing PFM/IC requires that a manager considers a range of issues that would not be considered with a more traditional public administration structure. With PFM/IC each manager should have an appreciation of the financial implications of decisions and all that this entails in terms of delivering objectives and performance standards efficiently and effectively. This involves a consideration of risk. What are the risks that could prevent a manager achieving the objectives efficiently and effectively? This should be a main concern of management. Without the existence of objectives, risk cannot be properly assessed. This goes beyond risk to systems although that is frequently how this is interpreted in practice and often emphasised by auditors.

The experience of this author in reviewing the implementation of PFM/IC in many of the countries of central, eastern, and southern Europe and some neighbourhood countries shows no practical recognition of this broader concept of internal control which should be associated with the idea of ‘management’. Similarly, there can also be a reference to the idea of ‘achieving efficiency and effectiveness’ but without the managerial arrangements, clarity of objectives and the financial and performance information systems and skills necessary to achieve it. Consequently, delivering efficiency and effectiveness remains a ‘nominal concept’.

2.8 The Ministry of Finance and Its Controls

Financial and budgetary controls are the controls with which the ministry of finance is primarily concerned not least because the traditional parliamentary concern is just about financial and budgetary control. They are also usually the only controls that are considered by those responsible for implementing public financial management reforms. However, both sets of controls are usually designed to meet the needs of the ministry of finance. They will require modification with the introduction of PFM/IC and particularly if the impact of the introduction of PFM/IC is to encourage parliament to widen its control interest to consider ‘outputs’ as well as ‘inputs’.

Whilst a ministry of finance should require that all non-market public organisations such as ministries, their second-level organisations and local governments implement financial controls, how successfully they are implemented depends upon several factors, including the following:

  • Is there any consultation by the ministry of finance with other public organisations about their content?

  • Is any attempt made to explain the controls to the top and senior management of line organisations and to convince them of their relevance and necessity: or is the attitude of the ministry of finance that these are requirements which have to be accepted, whatever the circumstances or costs?

  • Are the controls relevant to current needs and are they regularly updated?

  • Are they too bureaucratic and detailed?

  • Do the ministries and other line organisations responsible for service delivery see them as relevant to their needs as well as the needs of the ministry of finance?

  • Is the real aim of the controls to enable the ministry of finance to influence the policies and operational actions of the line organisations, even though the controls are ostensibly only for the purposes of financial (and budgetary) control?

  • Does any systematic consultation occur with ministries and other line organisations about the costs of implementing those controls and their relevance?

An example of a financial control activity that is frequently imposed upon senior officials in line organisations and in some countries upon politicians, but which is undesirable except for exceptional transactions, is a need for them to sign all invoices and payment schedules before payments are actually made.

So far as budgetary controls are concerned, those required by a ministry of finance should be those that are central to overall economic management and to the maintenance of parliamentary authority over the budget. Because with PFM/IC the budgetary analysis which suits a ministry of finance is most unlikely to be appropriate for managerial purposes an alternative, probably additional form of analysis will be required so that financial inputs can be linked to the achievement of outputs. Those controls may need to be extended should parliament broaden its interest to incorporate performance.

A question therefore is, do the budgetary control regulations issued by the ministry of finance recognise the change of circumstances generated by the introduction of PFM/IC, or indeed by any extension of parliamentary interest? Or are traditional controls being maintained because they enable a ministry of finance to effectively determine the policy of the spending or line ministry (as De Geyndt pointed out in the quotation in Chap. 1). In that circumstance, the reality will be that relatively junior ministry of finance officials will probably be responsible for the controlling or authorising decisions made by senior spending ministry officials. This is not conducive to the development of PFM/IC within spending ministries and other organisations and in particular to achieving efficiency and effectiveness.

Usually, ministries of finance impose controls without consultation and as a result top and senior officials of ministries and other public organisations may not see the need for such controls or may resent them. This can be especially true where senior managers are politically appointed and therefore have no civil or local government service backgrounds or experience. An important lesson for ministries of finance therefore is that with PFM/IC they should do their utmost through consultation and agreement to encourage spending ministries and other public organisations to ‘take ownership’ of these controls as far as possible rather than just seek to impose them without any consultation or recognition of their relevance to those organisation’s needs.

With PFM/IC a consequence of the shift from external to internal control will be that the ministry of finance should not be required to approve every variation to budgets or cash flow calculations because that in effect puts the ministry of finance in the position of the actual service manager even though the nominal service manager is located within a spending ministry or local government. The ministry of finance control should therefore change from a detailed form of control to a more strategic form of control. Consequently, instead of being required to approve every variation, the ministry of finance should focus only on the key or main changes proposed by line ministries or local governments whilst maintaining control of ceilings.

Even though a ministry of finance will need to recognise and accept that managerial requirements for budgetary and financial information are likely to be different from the requirements of the ministry of finance this does not mean in any way weakening or changing the information available to a ministry of finance but of recognising that managerial needs within a line ministry are, or can be, very different from the budgetary and financial management control needs of the ministry of finance. The core financial information should remain the same, that is, line ministry managerial information should be derived from the ministry of finance information systems and be capable of being reconciled with the ministry of finance information. (Further discussion about this is included in Chap. 5.)

2.9 Second-Level Organisations

Governments and local governments sometimes provide public services through agencies and state owned enterprises, that is, second-level organisations. Very often neither agencies nor public enterprises (sometimes called ‘public corporations’) are well managed or controlled by the relevant ministries or local governments. Controlling/owning ministries or local governments often lack an adequate policy capacity able to set objectives for second-level organisations and to effectively supervise their performance. As a result, there is a tendency for second-level organisations to dominate the relationships with the first-level organisation because the management of the second-level organisation has greater knowledge not just about the detail of the second-level organisation’s activities but also about its policy objectives and performance. This indicates a weakness in the accountability arrangements. As a result, decisions are likely to be made in the interests of the agency or enterprise rather than in the interests of the controlling/owning ministry or local government. Consequently, second-level organisations can be a significant source of inappropriate utilisation of funds and /or the development of activities which are inconsistent with the interests and objectives of the first-level body.

OECD evidenceFootnote 13 suggests that inefficient or poorly managed public corporations can impose substantial economic and fiscal costs.Footnote 14 The mere fact that public services or activities are provided on behalf of a ministry or local government by a second-level organisation should not exempt the controlling ministry or local government from incorporating them into the PFM/IC arrangements that apply elsewhere in the ministry or local government. The precise administrative arrangements may be different from those of the controlling/owning organisation, but the controlling ministry or local government should define what it expects of the agency or public enterprise. There is a responsibility upon controlling ministries and local governments to ensure that the agencies and enterprises they are responsible for deliver their objectives, meet performance standards and operate efficiently and effectively. This responsibility should be set down in some form of formal document which can change annually with an annual budget settlement or preferably over a longer period where the budget settlement is for a longer period. Such formal documents are often referred to as ‘service-level’ or ‘performance’ agreements. (A full discussion about the control of second-level organisations is included in Chap. 12.) The controlling ministry or local government should also systematically monitor the performance of the agency or enterprise against such an agreement.

What this consequently means is that the objectives, management, performance standards and governance arrangements of second-level organisations should be consistent with those of the first-level organisation and be subject to regular review. The management of second-level organisations should have clear objectives set for them by the first-level organisation, the resources and discretionary authority to make decisions about the delivery of those objectives should be defined in the agreement and they must be accountable for their successes and failures. This should require a change of managerial approach by first-level organisations which should follow from the introduction of PFM/IC.

2.10 The Head of Finance

With PFM/IC to be effective the role of the head of finance in an organisation becomes more significant. Managers at all levels, that is, including the political level, must be supported by a strengthened financial management capability. That capability requires the upgrading of the traditional finance officer role from that of bookkeeper/financial controllerFootnote 15 to become the equivalent of a finance director in a private sector company. That would mean ensuring that the head of finance and the department he/she is responsible for has a financial analytical capability, a financial planning and forecasting capability and an ability to act as adviser at all managerial levels in the organisation. The head of finance should be concerned about the efficient and effective utilisation of all the resources of the organisation including the available assets. The aim with the latter should be to encourage either more effective utilisation or, alternatively, disposal if assets cannot be demonstrably efficiently and effectively utilised.

The head of finance should have the status and ability to advise top and senior-level political as well as operational managers on the costs and financial viability of their plans and the objectives they wish to meet. They should also support both levels of management in the development of forward operational planning and have a capacity to prepare long-term forward financial plans. He/she should advise the managers (political and operational) about the long-run financial resilience of the organisation and therefore how it can be managed.

Overall, the head of finance should be responsible for securing the financial discipline processes that are essential with the development of PFM/IC. Ideally, he/she should work in partnership with the head of operational management. (A full description of the role of the head of finance is included in Chap. 8.)

2.11 The Time Horizon for Decision Making Under PFM/IC

A feature of PFM/IC relates to the time horizon for the delivery of public policy objectives. This is usually long term and rarely coincides with the time horizon envisaged in budgets even medium term (or 3 yearly) budgets or with the electoral cycle. Consequently, an important feature of PFM/IC should be an assessment of the longer-run consequences of public policy. Without that longer-run assessment managers (both policy makers and operational managers) cannot be sure that an organisation will be able to deliver its objectives or to remain financially viable over time. Financial viability over both the short and the long term should be a very important political consideration. If such viability is not a factor in policy making there is the possibility that at the extreme the organisation, if a body such as a local government or agency or state owned enterprise, may become bankrupt or incapable of continuing to operate without further cash injections which would be likely to be accompanied by stringent conditions. Or if the body is a ministry, it may require additional financial support which could have been avoided with more careful financial management and which in some circumstances may not be available. In a ministry, a lack of attention to the longer-run financial viability of the organisation may mean that it will have to make forced budgetary savings that can both be extremely wasteful and cause considerable discomfort to the users of the services provided by the organisation. Added to that, the reputational risk is substantial, which is likely to be of major concern to elected representatives. Consequently, those responsible for a public organisation should always consider the long-run financial strategy for the organisation and its long-run financial resilience. Politicians who have the ultimate responsibility for an organisation have a primary responsibility to ensure that adverse financial circumstances do not arise or, if they are likely to arise, for example, because of changes to government policy that the organisation is fully prepared. Financial viability and the achievement of objectives are intertwined.

Most public policy decisions made in one year have long-run implications which can extend well beyond the usual budgetary horizon. Although many countries have adopted a medium-term budget process, in practice those budgets are either based upon the current-year budget and spending plus an allowance for inflation or reflect the allocation of budgetary resources envisaged as available through the macro-economic planning process and government assessment of its priorities. This is not the same as organisation financial planning and neither do such arrangements form the basis for the development of a financial strategy. Public organisations will have to abide by any limits that are imposed but those responsible for the financial health of an organisation need to have a clear idea of what an organisation is committed to financially in the longer term and therefore of the consequences that restrictions on future finances may generate.

Where a long-run financial assessment has been made those responsible for an organisation are better placed to:

  • Negotiate with the ministry of finance about the level of financing that will be required, whether for investment or current funding.

  • Produce arguments to substantiate claims about the required level of financing.

  • Manage the process of changing a service to accommodate pressures for service cuts.

  • Develop plans to secure improvements in the efficiency and effectiveness of the services which are provided as part of a cost management process.

  • Develop awareness amongst service users of the likelihood of change and hence reduce the risk of a disruptive reaction to policy and service changes.

There are also the longer-run consequences of demographic change, the impacts of technology, the consequences of a better educated and wealthier population, environmental and climate change and other factors that cannot yet be properly foreseen. However, as far as possible, assessments should be made about their potential financial impact even if these can be only vaguely forecast. Attempts at spurious precision are not helpful. The questions that then arise are these:

  • Do policy changes need to be made now because current policies are financially unsustainable?

  • Does the management of the organisation envisage the possibility of longer-run changes to the operational environment, or other factors that could affect the future financial and operational viability of the organisation?

  • Are the present management arrangements capable of responding to those changes?

  • Do current policies need rethinking in any event to respond to these changes?

A specific example would be over the application of technology to a particular service or activity which is likely to require substantial investment, but which also may have a dramatic effect upon ongoing costs. Another example would be environmental changes, especially given the effects of climate change.

Financial management and internal control if properly implemented asks the types of question set out above. Take financial resilience: does anyone at present with traditional financial control and budgetary arrangements ask the question, can this organisation afford, within likely budgetary constraints and given the demographic and environmental changes which are occurring, to continue with its present policies over the next 5–10 years? Of course, to answer such a question does require speculative judgements to be made but it is either this or doing nothing and then suddenly finding that an existing policy cannot be pursued because the finance is not available, or it is not sustainable for other operational reasons. Trying to answer such a question at the very least encourages policy makers to consider the options that are available. Political time horizons will be shorter than those of appointed officials but asking this question does require the ‘official’ part of the organisation to prepare a strategy to take such possibilities into account and this will ultimately benefit political decision making. (Longer-run planning is also discussed in Chap. 8 on the role of the head of finance.)

2.12 Effective Public Financial Management and the Information Requirements

Effective public financial management introduces a demand by managers for a wide range of new information. That demand can also extend to parliament depending upon how it approaches its role given the introduction of PFM/IC. Information is central to effective management. If information needs are not fully considered, the management dimension to the PFM/IC reform is effectively being ignored. Managers will also require information to enable them to advise effectively on the development of policy and if policy is poorly defined it becomes difficult in turn to define objectives and to prepare budgets. However, information in itself is of little value unless the manager has the authority and capacity to use that information, that is, unless accompanied by appropriate delegation and managerial accountability arrangements. A manager requires information. That requirement must go beyond the limits of budgetary and financial controls because the responsibility of the manager is to deliver improvements in efficiency and effectiveness. That information requirement also extends to decisions made elsewhere in government because decisions made in one part of government can have an impact on other parts of government. The information required needs to include information that can affect both finance and performance such as changes to national or international standards. This does add to the cost and complexity of introducing the PFM/IC reform but without this additional information the manager will not be able to control costs or achieve improvements in efficiency and effectiveness or even deliver objectives (see above about the development of cost driver and cost centre analyses). Exactly what a manager’s information needs are will depend upon the manager’s specific responsibilities.

2.13 Achieving the Benefits of PFM/IC

2.13.1 Management and the Benefits of the Reform

The benefits from introducing PFM/IC derive from the impact that it has upon the management arrangements. The system itself does not deliver the benefits. The system creates opportunities for a manager that a traditional system does not and therefore what matters is the quality of the management if those benefits are to be achieved.

Evidence from other countriesFootnote 16 of the impact of public financial management reforms has shown that, firstly, many yearsFootnote 17 and in some cases many decades are required to implement substantive and sustainable changes. Secondly, political economy issues, together with the history and culture of a country, are enormously important factors in determining the success of a reform strategy. Strong public financial management systems are not created out of weak institutions and therefore an initial action should be to strengthen existing institutions as necessary (by, e.g., ensuring that the arrangements for PFA/IC are both sound and effective) and by encouraging parliament to take that broader interest in public finance referred to above (which may require support from the state auditor). Thirdly, prioritisation and the correct sequencing of the implementation of the reform are essential for the success of any reform strategy. Fourthly, capability constraints in the public administration play an important role. Strengthening capability is not about training alone. Capability is a wider concept. Capability includes the ability to mobilise and direct all resources to achieve an objective (finance, assets, personnel, IT systems and so on depending upon the organisation) in an efficient and effective way.Footnote 18 A further (fifth) factor that should under no circumstances be ignored is that financial management and internal control require a capacity to think and plan strategically. This is not a simple matter of the forward forecasting of the impact of events but also of how those events, together with cultural and environmental changes, are likely to affect how management should react and how the changing expectations of the electorate, the service user and the taxpayer will affect attitudes to public services and those responsible for their delivery in the future.

As experience of managing within a PFM/IC environment is gained further changes are likely to be required particularly to the definition of objectives, performance measures or indicators and the analysis arrangements designed to assist managers improve efficiency and effectiveness. Changes in technology will also impact upon the processes of financial management and internal control. Given the complexity and length of time that implementing PFM/IC will take, as was pointed out in Chap. 1, political consensus about the desirability of the reform is highly desirable. This will be particularly important where a consequential management change is to move responsibility for operational management from elected officials to appointed civil service and local government officials. This will mean that officials will need to be trained in management techniques and that the managerial ethos facilitates decision making and the making of operational service delivery judgements.

In summary the benefits of the reform are derived from a better quality of management with more efficient public services, an increased focus on achieving objectives and with greater regard for the needs and interests of the user of public services (effectiveness) usually expressed through civil society. (The benefits that can be obtained from this reform are discussed in Chap. 10.)

2.13.2 Integrating PFM/IC Reform with Managerial Reform

Given that the introduction of PFM/IC should be regarded essentially as a management reform the introduction of PFM/IC should be coordinated with civil service or public administration reform, although it rarely is. As has been pointed out a central feature of PFM/IC is the separation of responsibility for policy and strategy development from policy execution and all aspects of operational management with the delegation of operational management to civil service and local government officials. (The extent of delegation will depend upon the particular operational circumstances and where delegation is appropriate and where not is discussed in Chap. 14.) This means that a management structure should be developed which is appropriate to the needs of the organisation. However, the development of a management oriented organisation cannot simply be driven by the needs of PFM/IC. The development of a managerially oriented public administration, because of its far-reaching implications for policy development, the relationships between politicians and officials and staff management go well beyond the remit of a ministry of finance. However, the development of PFM/IC does mean that managers, at all levels, need to be financially aware. Financial awareness is not simply about knowing what budget is available and securing budgetary control. Financial awareness also means that managers know what the total costs are of the services or activities for which they are responsible and how any changes of whatever type will affect those costs (e.g. of those factors which drive costs). Where managers are responsible for the development and management of income sources, including taxation they need information on the effectiveness of the policies in achieving the objectives as well as information about the costs and losses on collection. They also need to be aware of the total resources, current and capital (investment), that they are using and of the commitments that they are proposing to enter into. This too may represent a significant change because very often administrators, such as heads of departments, in developing and transition economy countries are not aware of the total costs of the department for which they are responsible because some costs may not be allocated over services and activities and in some countries, particularly lower-level administrators, may not know at all of either the budget they have available or the actual costs that are being incurred. The only financial information that it is often deemed necessary for an administrator to know is that necessary to maintain budgetary control over those expenditure lines for which the administrator has a direct responsibility. With PFM/IC this nowhere near enough! Neither is it enough for only the finance department to be responsible for the effectiveness of the financial and budgetary control arrangements: this should be primarily the responsibility of the manager. A particular responsibility of the head of finance is to promote financial awareness in all its aspects amongst managers (see next section).

2.13.3 Promoting Financial Literacy and Awareness

Managers need budgetary and financial information which meets their needs and as has been explained above these needs will be different from those of the ministry of finance. Whilst budgetary control must be maintained in accordance with the requirements of the ministry of finance that budgetary information needs to be reanalysed in a manner which supports the manager and as far as possible linked to performance information. Only by this occurring can a manager assess how efficiently and effectively services are being provided and through that the development of financial awareness. This also supports the development of managerial accountability. That will mean providing individual managers with the specific budgetary and accounting information they require to enable them to manage their part of the business of the organisation. To meet these different requirements more sophisticated financial analytical processes will be necessary. A single coding structure for the whole of government will be most unlikely to have the capability to achieve this. In developed economy countries the problem has been addressed by allowing public organisations to develop their own coding structures but in accordance with conditions specified by the ministry of finance that allow the ministry of finance to maintain the control and financial information it requires. A specific example is provided in Chap. 5.

Reluctance often exists in many developing and transition economy countries to provide budgetary and financial accounting information to managers other than to the top level of management and in any form other than that required by a ministry of finance. This will need to change.

2.13.4 Engaging a Wider Set of Actors in Financial Decision Making

Rather than confining debate about budgetary allocations to senior officials, line ministry and local government managers at all levels ought to be involved in decisions affecting the level of budgetary allocations (within any overall ceilings) given the objectives and performance standards they are expected to meet. They should also be involved in decisions about budgetary variations required during the year and cash flow calculations. In summary, if those managers are to be responsible for the delivery of objectives, performance standards and levels of operational performance they need to agree the resources necessary to do so and if resource availability is not at the level to achieve them, then changes will need to be made to objectives, performance standards or performance levels to match the available resources. Only the manager is in a position to give advice on that.

2.14 Learning Lessons from the Experience of Countries Aiming to Introduce PFM/IC

Where countries have not had regard to the managerial dimension to the PFM/IC reform the impression is that they have not asked themselves these questions:

  • Who is to use the information derived from those bureaucratic proceduresFootnote 19 that are associated with the implementation of PFM/IC, how is it to be used and is it reliable?

  • Does an appropriate management structure exist reflecting the objectives of the organisation with experienced managers in place?

  • Do those managers have clear objectives and have performance standards been set for them, with both linked to their budgets, and is performance information available?

  • Do managers have the appropriate financial and budgetary information along with performance information to enable them to make judgements about the efficiency and effectiveness of the operations for which they are responsible?

  • Do managers have the delegated authority to act in order to deliver those objectives?

  • Do appropriate arrangements exist to hold managers to account, including by parliament and by civil society?

Unless these questions can be answered positively the main point of the reform is being missed and the potential benefits will not be achieved.

Also, the linkages between this reform and public administration reform or civil and local government service reform have not been recognised. In most countries, public administration reform and PFM/IC reform operate as it were, on parallel lines, not recognising the significant relationships between the two. What has also been missing is a recognition that budgeting and financial accounting systems also need to meet the needs of line ministry managers as well as those of the ministry of finance. Some budget headings which may be currently centralised in some countries (such as personnel and premises costs) may need to be allocated over individual management areas of responsibility to provide managers with the information that they require if they are to deliver services efficiently and effectively.

These weaknesses in the approach to the financial management and internal control reform appear to have partly come about, at least in countries with a legalistic tradition of public administration, because of the traditional focus upon adherence to that legalistic approach exemplified by bureaucratic rules and procedures. The legal approach has a focus on structure and functions allowing the exercise of power. It emphasises formality, the powers available and the limitations of power. It affects the discretionary authority of administrators. This contrasts with the approach exemplified in PFM/IC where the focus is more upon the public service user, the outputs, efficiency, and effectiveness in delivering those outputs. The legalistic approach in these countries also reflects concerns about the misuse of funds leading to a focus upon ‘financial and budgetary control’. The reform approach that has been adopted in many countries has been to strengthen public financial administration, not ‘management’. However, that also reflects a limited view of the meaning of ‘control’. An internal audit based approach, which is the point from which many developing and transition economy countries start the reform, with a focus on compliance with procedures and systems to ensure that they are properly implemented has been usually the approach adopted. Whilst such controls are very important, thought has not been given to the outputs of those procedures and systems. This is not the end outcome that PFM/IC is aiming for. It ignores the point set out above in this chapter that ‘control’ is also about ensuring that the organisation delivers its objectives and does so efficiently and effectively and without risk to the financial resilience of the organisation. In other words, ‘control’ is also about where the organisation is heading and how well it is using its resources. That is a management responsibility. To use a motoring analogy, control is about more than just the accelerator and brake (i.e. the systems and procedures), it is also about steering towards the objective (i.e. where is the organisation trying to get to). Consequently, implementing PFM/IC in countries with a legal tradition does mean a significant cultural change and cultural change in all circumstances is very difficult requiring careful preparation.

The lesson from this is that whilst the experience of other countries can be valuable it does need to be treated with great care recognising that many (perhaps most) other countries have had a very narrow perception of what this reform is mainly about in that they have not recognised the managerial impact of the reform.

2.15 PFM/IC and Delegation

Countries with highly centralised power structures may have difficulty with the concept of delegation. There are two aspects to delegation, one is from politicians to the civil or local government service officials and the other is from central organisations to line organisations such as individual ministries.

The first aspect from political appointees to officials tends to occur because of a lack of ‘trust’ in the civil or local government service officials and concerns about competence. This can be accentuated where the civil and local government service has been politicised and has no reputation for independence. Power also provides important benefits to those who hold it, such as patronage and in some countries, as has been said earlier, opportunities for rent seeking. This is unlike in those developed economy countries, such as the Netherlands and other western European countries which have a long history of implementing PFM/IC. Here responsibility for delivering operational activities lies with the civil and local government officials and policy and strategy development and monitoring lies with politicians, that is, the elected officials. Exactly where the boundary lies between policy and strategy and operational activity varies considerably from country to country, as do the reporting arrangements, but either the civil and local government service is not politicised or politicisation is strictly limited.

The second factor is that in many developing and transitional economy countries power may be concentrated in a limited number of central ministries such as the ministry of finance (or there may be a separate ministry responsible for investment control) which may have to approve spending decisions where they do not conform with traditional practice, or cause variations to existing budgets. Or again a central ministry may be responsible for all employment levels and arrangements and this central ministry may have to approve personnel changes or appointments. This limits the discretion of line ministries to make decisions about the way in which services are delivered and how they can be made more operationally efficient. In practice, such controls are not related to the efficient and effective delivery of a service or the achievement of objectives but are simply about budgetary or policy control and sometimes a perceived need to avoid creating precedents. Such arrangements conflict with the managerial responsibility to improve efficiency and effectiveness and where authority must be sought from another organisation, decisions are likely to be made in the interests of the organisation exercising the power. Therefore, for example, where a line ministry may require a change to budget structures or change the personnel structure to facilitate improvements in efficiency and effectiveness meaning that a different form of budgetary analysis is necessary or different personnel arrangements, a central ministry can effectively prevent this if it will not agree to those reforms that a line ministry may require. A legitimate question then is who in fact is the manager of that service or activity?

2.16 PFM/IC and Decentralisation

Decentralisation transfers authority and responsibility from central government to regional and local government of certain government functions. This responsibility may include all aspects of service delivery from policy formulation, the strategy for implementing that policy to the detailed arrangements for service delivery. Exactly what the arrangements will be depends upon individual country arrangements. An important factor affecting decentralisation will be the level of financial resources available to each level of government. Some subordinate governments may have local taxation resources but usually these are insufficient to finance the costs of the more major public services such as education or poverty relief or security. In such circumstances local revenues sources are usually supplemented through grants from central governments which can attach conditions to the provision of grant aid including conditions about how such funds are to be managed, for example, by the adoption of PFM/IC.

With the introduction of PFM/IC at the central government level a decision will need to be made about its implementation by these different levels of government. How far a central government can impose a requirement for a subordinate government to adopt particular managerial or administrative arrangements will depend very much upon the local constitutional arrangements. Whilst a central government can use the lever of the provision of financial resources to encourage or cause subordinate governments to undertake reform, there may also be other reasons why central governments should require subordinate governments to undertake reform. An example is of governments wishing to join the European Union where the equivalent of PFM/IC is expected to be adopted by both central and local government as well as any intermediate levels of government.

The ideal position though is that all levels of government within a country should be encouraged or required to adopt PFM/IC recognising that the timetable and the specific arrangements may well be different from those applying to central government.

2.17 Summary

The PFM/IC reform is likely to challenge the traditional cultural approach to the delivery of public services. It also affects the distribution of power within and between organisations and affects how some organisations have traditionally operated as well as the roles that they have traditionally undertaken, including the parliament. This can make the reform difficult to implement. However, as a key component of PFM/IC, namely management with the responsibility to deliver objectives efficiently and effectively, this inevitably will lead to challenge to existing power structures particularly with the development of a delegated but much more disciplined managerial approach to the delivery of public services and activities. It will also require a more flexible attitude to budgeting and financial accounting compared with traditional arrangements.

Some civil and local government officials will appreciate the benefits of this, but others could object especially as their ‘comfort zones’ will be challenged with them being expected to accept new responsibilities that could be potentially frightening and risky.

The possibility is that together these concerns will generate resistance to the reform and may cause those responsible for the reform to argue that either it is not really relevant to the needs of the country or it so runs against the grain of the culture of the country that at least some aspects of the reform are inappropriate. In some countries the result has been that the PFM/IC reform has been quite superficial and limited to legal changes and requirements but with no substantive management or budgetary or accountability changes. Delegation often has been limited and largely restricted to relatively minor administrative matters. Because delegation has been so minor, the accountability arrangements have also been of superficial impact. Therefore, there is little or no prospect of achieving the benefits of the reform.

Another important lesson from those countries that have sought to implement a PFM/IC reform is that to be effective it must be complemented by a public administration/civil service reform. (That too has not always been appreciated.)

Given the difficulties with implementing and sustaining a full PFM/IC reform, what the reform may only in practice result in is improvements to public financial administration. This in itself could well be an important step forward, as well as a necessary step as a precursor to the much more substantive managerial PFM/IC reform. The important point is that those with the ultimate responsibility for reform should recognise this.

Overall, the objectives of PFM/IC are to ensure:

  • Public services are managed and delivered efficiently and effectively and that a focus exists upon the user and the delivery of objectives and performance standards, not just financial and budgetary control.

  • No commitments are entered into which risk the short-, medium-, or long-term financial resilience of the organisation.

  • Full and effective accountability exists to the parliament, to the user of public services, to the taxpayer and to the population, showing how public resources have been raised and used, how effective internal controls (defined more broadly than simply budgetary and financial control), have been.

  • The extent to which government objectives have been achieved and whether they have been achieved efficiently and effectively.