How budgetary institutions can improve fiscal outcomes

• Author: Stefania Fabrizio/Ashoka Mody
• Position: IMF European Department
• Pages: 13

Page 13

Political economists have reached important, though rather pessimistic, conclusions about long-term influences on fiscal performance. In their view, more representative electoral systems achieve inclusiveness at the cost of reduced political and fiscal discipline. In societies divided along ethnic or religious lines, electoral systems accommodate these interests but, in turn, promote coalition governments that result in greater competition for fiscal resources. According to recent work by the IMF's Stefania Fabrizio and Ashoka Mody, effective budgetary institutions-the mechanisms and rules of the budget process-can provide a useful check on the strong influences of history and politics.

The European Union experience

To explore the difference budgetary institutions can make, the authors isolated their role and controlled for a comprehensive set of economic and political conditioning factors, such as inflation, the unemployment rate, electoral systems, and government fragmentation and ideology. They then focused on the new and potential member states of the European Union between 1997 and 2003. These countries represent an important historical experiment, because they offered the opportunity to observe changes over time in the quality of fiscal institutions.

In anticipation of acceding to the European Union on May 1, 2004, the prospective members made a commitment to budgetary discipline. Despite the common commitment, however, performance has not been uniform. Estonia, for example, managed its public finances well, even running a primary surplus in some years. Poland improved its fiscal position in the late 1990s, running a surplus in 1999 and 2000, but drifted back to deficits thereafter. Hungary's budget balance generally worsened.

The countries also have different legacies. Whereas the Baltic nations have small governments, Hungary and Poland and, to a lesser extent, the Czech Republic have large governments, with expenditure-to-GDP ratios that show a tendency to increase along with per capita incomes. All of the new member countries face significant challenges, not least because they have adopted proportional electoral rules that, to varying degrees, increase the likelihood of coalition governments and thus generate budgetary pressures.

Despite the small country sample, the robustness of its principal findings strengthens the case for specific institutional or rule-based measures to curb...