Download 6. Medium-Term Expenditure Framework: Lessons

Reforming the Fiscal
Management System in Korea
June 2005
Youngsun Koh
Korea Development Institute
-2-
The Role of Fiscal Policy

Traditionally, three roles are assigned to fiscal policy:
• Reallocating the resources in the economy by providing
public goods in the hope of correcting market failures.
• Redistributing income and wealth with the tax and benefit
system and also with the public education and other services.
• Stabilizing the macro-economy in the short and long term.
– A counter-cyclical fiscal policy, if implemented
appropriately, can help to smooth out the short-term
cyclical fluctuations.
– Fiscal policy can contribute to a stable, long-term growth
and low inflation by maintaining sound budgetary
positions and limiting the rise in public debt.
-3-
Budget Balance
Fiscal consolidation in the early 1980s restored the budget balance
to a sustainable path.
Budget Surplus/Deficit
Korea
4
3
2
1
0
(% of GDP)
OECD
4
3
2
1
0
(% of GDP)
-1
-2
-3
-4
-5
-1
-2
-3
-4
-5
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Note: Consolidated central government.
Source: Ministry of Finance and Economy.
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Note: General government.
Source: OECD.
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Spending Growth
Fiscal consolidation in the 1980s took the form of expenditure
restraint rather than revenue increase.
30
25
(%)
Growth of Real Expenditure and Revenue
Real growth in expenditure and net lending
Real growth in revenue
20
15
10
5
0
-5 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03
-10
-15
Note: Real values were obtained by deflating nominal values with GDP deflator.
Source: Ministry of Finance and Economy.
-5-
Government Liabilities
The debt-to-GDP ratio declined steadily since the early 1980s
but increased rapidly after the crisis.
Government Liabilities
Note: Central government.
Source: Ministry of Finance and Economy.
Italy
Japan
Greece
Belgium
France
Note: General government, at the end of 2003.
Source: OECD.
Canada
Spain
Germany
Austria
United States
Portugal
Sweden
Finland
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Netherlands
0
Poland
5
United Kingdom
10
Denmark
15
Iceland
20
Slovak Republic
25
Norway
30
New Zealand
Central government liabilities
(% of GDP)
160
140
120
100
80
60
40
20
0
Korea
Guarantees
Australia
35
(% of GDP)
Luxembourg
40
OECD
Ireland
Korea
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Government Liabilities
During the early days of government-led economic growth,
foreign borrowings played a crucial role in providing the resources
for public and private investment.
Debt / GDP Ratio
(% of GDP)
50
Government guarantees
Procurement on Credit
Foreign borrowings
40
Domestic borrowings
Government bonds
30
Central government debt
20
10
0
53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04
Sources: 1953-90, Korea Development Institute; 1991-2003, Ministry of Planning and Budget.
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Size of Spending
Expenditure and net lending as % of GDP declined throughout the
1980s and then rose in the 1990s.
Central Government Spending and Revenue
25
(% of GDP)
Expenditure and Net Lending
Revenue
23
21
19
17
15
13
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Source: Ministry of Finance and Economy.
-8-
Size of Spending
The total government spending corresponded to 23.0% of GDP,
much lower than in other countries.
General Government Expenditures
(% of GDP)
50
Transfer
Interest payment
40
30
20
Subsidies
Investment
10
Consumption
0
Korea
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Source: OECD
U.S
Japan
Others
Germany France
U.K.
Canada
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Tax and Social Security Burden
The increase in spending has been accompanied by an increase
in tax and social security burdens.
Tax Burden and Social Security Burden
Korea
OECD
Sweden
Finland
Denmark
Austria
Belgium
France
Italy
Norway
Lexemburg
Hungary
Netherland
U.K
Czech Rep.
03
Greece
01
Iceland
99
Germany
97
Spain
95
Turkey
93
Canada
91
Poland
89
New Zealand
87
Portugal
85
Slovak Rep.
0
Australia
5
Switzerland
10
U.S
15
Tax revenues
Ireland
Tax revenues
20
Social security contributions
Korea
55
50
45
40
35
30
25
20
15
10
Social security contributions
Japan
25
(% of GDP)
Mexico
(% of GDP)
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Sectoral Allocation of Spending
Economic affairs has taken the largest share in total spending.
The spending on social protection is on the rise after the recent
crisis.
Trends of Expenditure and Net Lending
(% of total expenditure and net lending)
General public services
Defense
Public order and safety
Education
Health
Social protection
Housing and Community
Amenities
Recreation, culture, and religion
Economic affairs
Other expenditures
Source: Ministry of Finance and Economy.
1970
1980
1990
2000
2003
23.1
22.7
16.7
1.3
4.9
0.3
4.0
30.6
4.6
14.6
1.0
5.7
2.5
4.2
20.0
4.3
17.0
1.7
8.1
10.1
5.2
11.4
4.6
15.3
0.7
15.3
5.3
6.7
11.4
5.3
15.0
0.4
13.5
5.0
1.4
27.4
2.2
0.7
26.0
10.4
0.5
20.4
13.7
0.8
25.2
16.2
0.8
28.7
12.8
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Spending on Economic Affairs
Spending on economic affairs corresponds to 6% of GDP, far
higher than those in advanced countries.
Spending on Economic Affairs
(% of GDP)
7
6
5
Other economic
Affairs
4
Transportation
and communication
3
2
Mining,
manufacturing, and
construction
1
Agriculture and
fisheries
Fuel and energy
0
US
Germany
France
UK
Canada
Note : Central government for Korea and general government for others.
Source : IMF.
Korea
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Government Lending
The spending on economic affairs often takes the form of lending.
Government Lending
9
(% of GDP)
8
New loans
7
Net lending
6
Outstanding Stock of Loans
(% of GDP)
30
25
Gross liabilities
Outstanding stock of loans
20
5
4
15
3
10
2
1
0
-1 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Note: Net lending = new loans - repayments.
Sources: Ministry of Finance and Economy.
5
0
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03
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Coping with the Crisis of 1997
During 1998-2002, the government made loans to the Korea Deposit
Insurance Corporation (KDIC) and the Korea Asset Management
Corporation (KAMCO) in the amount of interest payment on
the restructuring bonds issued by these corporations.
The government also provided guarantees on these bonds.
In 2002, the government announced a plan to take up the obligation
on part of the bonds (49 trillion won) and transform them into
treasury bonds. The rest would be repaid by the KDIC and KAMCO.
In 2003, 13 trillion won was spent on the transformation. The figure
for 2004-2006 is 12 trillion won each year.
In addition, the government expanded the welfare programs
significantly to help the poor and the unemployed.
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Assessment

Overall, fiscal policy in Korea has carried out its roles rather
successfully:
• Resource allocation: The emphasis was placed on
promoting the economic growth with large spending on
education, infrastructure, and other public goods.
• Income distribution: After the crisis, spending on social
protection is increasing rapidly, and is expected to increase
further in coming years.
• Stabilization: The prudent management of fiscal policy
contributed to a sound budgetary position and a low debt-toGDP ratio.
– But the short-term stabilization has been limited due to
the small sizes of tax revenues and welfare spending.
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Assessment
The Korean economy recorded an average growth rate of around
8%. The inflation was reduced drastically in the early 1980s and
declined further after the crisis of 1997.
30
(%)
25
20
Output Growth and Inflation
Gross Domestic Product
Consumer Price Index
15
10
5
0
-5 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03
-10
Source: Bank of Korea.
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Assessment
Korea is also known as a country with a relatively equitable
distribution of income, even though the inequality rose
significantly after the crisis.
8
(%)
Labor Market Indicators
(%)
Gini Coefficient
64 0.5
Economic participation ratio
6
61
0.4
0.3
4
58
0.2
Mexico (1998)
U.S (2000)
Russia (1995)
U.K (1999)
Korea (2000)
Italy (1995)
Ireland (1996)
Australia (1994)
Switzerland (1992)
Spain (1990)
Canada (1998)
Korea (1996)
France (1994)
Czech (1996)
Sources: National Statistical Office; Hyun (2003) and Yoo (2004).
Germany (1994)
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
Finland (2000)
52 0.0
0
Netherlands (1994)
0.1
Poland (1999)
55
Norway (1995)
Unemployment rate
Sweden (1995)
2
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Challenges

Containing the spending growth
• Revenue growth is expected to fall in line with output growth.
• Spending is on a rising trend due in large part to the
increasing welfare spending, especially on pension and
health.

Redefining the role of government
• Reducing the direct support to businesses.
• Expanding basic public services such as judicial services,
promotion of competitive business practices, statistical
services.

Enhancing the efficiency of spending
• Promoting the autonomy and accountability of line ministries.
• Greater focus on outputs and outcomes.
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Complicated Budget Structure
General
account
(1)
• Revenue sources: general-purpose taxes and non-tax
revenues.
• Carry-over: not allowed in principle.
• Asset holding: not allowed.
• Managed through the treasury single account.
Special
account
(23)
• Revenue sources: ear-marked taxes, levies, and other
revenues.
• Example: Transportation Infrastructure Special Account.
• Carry-over: not allowed in principle.
• Asset holding: allowed.
• Managed through the treasury single account.
Public
funds
(57)
• Revenue sources: ear-marked taxes, levies, and other
revenues.
• Example: National Pension Fund.
• Carry-over and asset holding: allowed.
• Can change spending up to 30% without approval from MPB
and the National Assembly.
• Managed independently by line ministries .
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Reforming the Budget Structure

Public funds
• Previously, public funds were off-budget; they did not need to
go through the approval process of the National Assembly.
• Now the same approval process is applied to public funds as
to the general and special accounts.
• The revised Basic Law on Public Fund Management
mandates MPB to examine the raison d’etre of individual
funds every 3 years and to recommend their abolition or
consolidation when needed.
– The first such exercise was carried out last year.

Special accounts
• The government is currently preparing a plan to restructure
and streamline special accounts and public funds.
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Major Players in the Budget Process


Presidential system of government
Ministry of Planning and Budget (MPB)
– Prepares the budget and tables it on the National Assembly.

Ministry of Finance and Economy (MOFE)
• Treasury Bureau
– Releases cash to spending ministries.
– Issues treasury bonds and manages assets and liabilities.
• Tax and Customs Office
– In charge of tax policy and revenue forecasts.

Board of Audit and Inspection (BAI)
– The supreme audit institution in Korea, reporting to the
president.


National Assembly
Line ministries
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Highly Centralized Budget Process

Strategic dominance-based approach (von Hagen and Harden, 1996)
Budget
preparation
and
finalization
• The MPB has a clear upper hand vis-à-vis line
ministries in budget negotiations.
• The National Assembly is prohibited from
increasing the total spending or introducing new
spending items without consent from the
government.
Execution
• Strict cash limits are imposed on ministerial
spending by the MOFE.
Ex post control
• The BAI performs both financial auditing and
regularity check of ministerial activities.
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Signs of Weakened Fiscal Discipline

The MPB devoid of policy coordination function
Economic Planning
Board (EPB)
Ministry of Finance
(MOF)
(1970s and 1980s)
Ministry of Finance
and Economy (MOFE)
(Early 1990s)
Ministry of Planning
and Budget (MPB)
Ministry of Finance
and Economy (MOFE)
(Late 1990s to this day)
Democratization of the Korean politics
• The balance of power tipping toward the legislature
 Increased public demand for active fiscal policy to boost the
economy
• More supplementary budgets introduced during a year
• Front-loading of annual spending
 Transition toward a target-based approach being called for

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Introducing an MTEF

MTEF (medium-term expenditure framework)
• Preparing annual budgets with a medium-term perspective in
a top-down way
• Introduced in Korean in 2004 with the publication of the
National Fiscal Management Plan (2004-2008)
Planning
horizon
Next single
budget year
Balanced
budget
Each year
On average over
the business cycle
Budget
allocation
Bottom-up
Top-down
Focus of
control
Inputs
Outputs and
outcomes
Attention
General
account
All accounts
and funds
3-5 years
in the future
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Pros and Cons of MTEF
• Better able to cope with the trend increase in spending,
especially when annual spending ceilings are set up and
observed over the medium term (a target-based approach).
Pros
• Stronger linkage between policy-making and budgeting.
• Full operation of the automatic stabilizer.
• Greater autonomy in line ministries.
• Spending projections becoming “entitlements” for line
ministries.
Cons
• Deficit bias when macro-forecasts are overly optimistic.
• Greater room for waste, fraud, and abuse in line ministries.
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Improving the MTEF
– Performance management to be strengthened and the capacity
for planning and prioritizing to be improved in line ministries.
– The capacity for policy analysis and macro-forecasts to be
enhanced in the MPB.
– The medium-term targets in the MTEF to be clarified and the
annual operational targets to be set out.
– Various risk analysis to be introduced.
– A mechanism for “baseline” projections to be established.
– A reconciliation process to analyze the difference between
projections on fiscal aggregates and outturns to be established.
– Internal auditing to be strengthened.
– “Program budgeting” to be introduced.
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Diverse Initiatives for Performance Management
Performance
Management
System
(MPB)
Government
Operations
Assessment
System
(OGPC)
SelfAssessment
of Spending
Programs
(MPB)
Performance
Management
Performance
Audit
(BAI)
Management
by Objectives
(MOGAHA)
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Performance
Management
System
(MPB)
• Adopting the framework in the Government
Performance and Results Act (GPRA) of the U.S.
federal government.
• Requires line ministries to set up performance goals
and indicators for major spending programs, and
prepare annual performance plans and reports.
• Has not been very successful.
• Assesses the performance and organizational capacity
of ministries and citizen satisfaction with them.
Government
Operations
Assessment
System
(OGPC)
• Relies mostly on the subjective assessment by outside
experts and in-house staff.
• Assessment results are reported to the President in
biannual cabinet meetings.
• From 2005 on,line ministries should establish
performance indicators and announce target levels in
annual business plans.
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• Designed after PART (Program Assessment Rating
Tool) of the U.S. federal government.
SelfAssessment
of Spending
Programs
(MPB)
• Requires line ministries to assess their own programs
with spending levels above a certain threshold over a
cycle of 3 years.
• The assessment is based on a series of questions
asking the appropriateness of program design,
program management, and performance assessment
and feedback.
• MPB reviews the assessment results and takes them
into account in budgeting.
Management
by Objectives
(MOGAHA)
• Sets annual performance targets for civil servants and
reflects the results on their pay and promotion.
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Improving Performance Management
– Consolidating diverse initiatives into an integrated
system of performance management.
– Establishing a sound system of planning and reporting.
– Emphasis on program evaluation.
– Introducing a program structure in budget accounts.
– Greater use of performance contracts.
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Other Reform Efforts


Works are underway to:
• Redefine the scope of “general government.”
• Introduce accrual accounting in financial reports.
– For now, budgeting in contrast to financial reporting will
continue to be based on cash accounting in the
foreseeable future.
• Redesign the IT system to accommodate the changes
mentioned above.
Budget and Accounting Reinvention Office (BARO) was formed
to tackle these issues in addition to the introduction of program
budgeting.
• BARO members consist of secondees from MPB, MOFE,
BAI, etc.
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To Summarize..


Many efforts to modernize the fiscal management system after
the crisis of 1997.
• The government began the reform process on their own
initiatives.
Major points
• Streamlining the budget structure
• Introducing the MTEF
• Strengthening performance
management
• Redefining the scope of
government
• Introducing accrual accounting
Aggregate fiscal
discipline
Allocative and
technical efficiency
Transparency