Why context matters in public finance management reforms

Two decades ago, when I interned at the French Embassy’s economic mission in Moscow, I was asked to look into bankruptcy laws and their implementation. The Embassy wanted to advise French companies on how to get business done in the new Russia—we are talking mid-1990s—when there were no reliable guidebooks on how to navigate the transition to a market economy.

So I was asked to read recently approved, Western-inspired bankruptcy laws, given a phone book and asked to find two dozen companies around Moscow. I was to meet with their CEOs and find out how insolvency and bankruptcy procedures actually worked in practice.

I came away with one key finding: the rules on the books were not a very useful guide to how bankruptcy worked in practice. In fact, the distortions brought about by hyperinflation, bartering and the transition from Soviet to Western accounting meant the liquidity and solvency ratios that underpinned the institution of bankruptcy had essentially become meaningless.

A number of imaginative, well-connected creditors had decided to take advantage of this chaotic transition from a centrally controlled to a market driven economy. They convinced some judges to work with them and compel a sample of the most valuable businesses in Moscow, those that held sizable real estate holdings, to file for bankruptcy.

As soon as this was done, real estate assets were stripped, sold for a song to the creditors who had triggered the legal action in the first place and transformed into juicy real estate deals, with the well-oiled complicity of local government officials.

The paradoxical effect of the implementation of the bankruptcy laws in this particular context was that only the most valuable businesses had a realistic prospect of being declared bankrupt. Judges were not interested in processing other cases.

What I learned from this formative experience was that context matters – bankruptcy did not have the same meaning in the US as in Russia, even though the formal rules on the books may have looked similar. This has profound implications for work in development.

As development practitioners, we assume that apparently identical rules and procedures, say on budget execution or parliamentary oversight, have the same impact in London and Abuja or in Paris and Bangui at our peril.

As my colleagues and I argue in a recent paper, this distinction between rules on the books and the way the public sector actually functions is critical to understanding public financial management (PFM).

When developing countries undertake PFM reforms, usually presented as “best practices”, the key objectives—fiscal prudence, budget credibility, reliable and efficient resource flows and institutionalized accountability—often get lost in translation.

Instead, what we too often end up with are reforms that are used as “signals” of the good intentions of the authorities to the outside world. Yet, despite these formal changes, the underlying functions are not really better performed by the public sector. What we have are Potemkin reforms.

We have a new procurement code and an independent procurement authority, but is there value for money in road construction? Or is the taxpayer paying for eight inches of road and getting only four? We have a brand new Integrated Financial Management Systems (IFMIS) to execute our budget, but are there stock outs of essential pharmaceuticals despite vast sums of money being spent on their purchase?

We have a Supreme Audit Institution and a Public Accounts Committee, but is the head of the power utility being held accountable when millions of dollars are wasted on inefficient, badly maintained diesel generators that break down after a few months?

As we argue in the paper, part of the problem is that what typically gets measured in PFM is the existence or formal approval of the rules on the books, standards, systems and “best practices” that, if correctly implemented, should in theory help improve these core functions.

Unfortunately, this is a very unreliable gauge of PFM performance. Like in the Russian bankruptcy example, in PFM the gap between rules, systems, procedures and their actual implementation can be very large indeed.

This does not mean of course that we should throw the baby with the bathwater – just because the introduction of an IFMIS does not always yield the intended functional improvements, it does not follow that we should never support IFMIS reforms.

What it means  is that, in order to successfully introduce an IFMIS, it is critical to understand the context, the functional problem the authorities are trying to solve, and to pay close attention to those who need to be in the room in order to effect a change in behaviors.

This is an exciting agenda, one that calls for a different way of supporting PFM reforms and doing development.

This article originally appeared on The World Bank’s Governance for Development Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Renaud Seligmann is currently Manager of the West and Central Africa Financial Management Unit at the World Bank.

Image: The word “Bankruptcy” is painted on the side of a building in Detroit. REUTERS/Joshua Lott.