The budget is a numerical indication of how much funds will be mobilized and utilized to implement government policies during a certain period of time. It not only affects the allocation of national resources across various sectors in the economy but ...
The budget is a numerical indication of how much funds will be mobilized and utilized to implement government policies during a certain period of time. It not only affects the allocation of national resources across various sectors in the economy but also plays an important role in income distribution and macroeconomic stabilization. The budget authority has the mandate to assess the spending bids of ministries and agencies and allocate funds in line with national priorities. It cannot accommodate all allocate funds in line with national priorities. It cannot accommodate all spending bids due to the limit on total available funds and the necessity to maintain a stable macroeconomic environment.
In fact, no amount of funds is sufficient to satisfy all the demands from government departments, members of parliament, and other interest groups. Many expenditure programs benefit only small segments of the population while their costs are spread among various parties. The disparity between the marginal benefit and cost often increases public expenditure beyond a socially optimal level. The difficulty for the budget authority lies in overcoming such "tragedy of commons" and preventing an excessive spending growth and budget deficits.
In both advanced and developing countries, it is not uncommon to observe large budget deficits and rising government liabilities. Unlike these countries, however, Korea has maintained strong fiscal position since the latter part of the 1980s. A natural question to ask is, which factors differentiate Korea from other deficit-ridden countries? Can these factors explain the rapid improvement in Korea's fiscal position in the 1980s?
Past studies on budget deficits mostly focused their attention on budget processes and fiscal rules. A prime example is the hypothesis proposed by von Hagen and Harden who emphasize centralization of the budget process as the most important factor for fiscal soundness. According to them, the approach to centralization can take one of two forms. In a strategic-dominance approach, the bargaining power is centralized at the budget authority which exercises strong leadership over line ministries to control the expenditure growth. In a target-based approach, a target is agreed upon at the early stage of the budget process and all participants, including the budget authority and line ministries, are obliged to observe the target throughout the process.
Among the OECD countries, centralization of the budget process looks indeed a defining characteristics of those which have maintained relatively high degrees of fiscal soundness such as U.K.. But when we shift our attention to developing countries, we can find many instances where a centralized budget process coexists with persistent fiscal deficits.
Korea is a case in point. The budget process in Korea has been highly centralized since the early days of economic development. The budget authority has traditionally enjoyed high status vis-a-vis other ministries within the executive branch. Undue influence from the heads of state (Presidents) and other politicians on budgetary decision-making has generally been restrained. However, the Korean government ran large fiscal deficits in all years during the 1970s. Then with no obvious change in the centralizing power of the budget authority, massive efforts were made for fiscal consolidation in the early 1980s and finally brought about surpluses in the latter half of the 1980s. The budget has remained more or less in balance since then.
This study contributes to the current discussion on the determinants of fiscal soundness by pointing out the decision-making system within budgetary organizations as another important determinant. Specifically, it is argued that the Budget Review Board (BRB) that came into existence in the early 1980s has played an important role in restoring and maintaining fiscal soundness in Korea. BRB was composed of high-ranking officials and division chiefs in the Budget Office. Collective review of departmental bids in an open and democratic atmosphere promoted rationalism in budget formulation and minimized the interference of political considerations.
This study tracks the changes in the organization of BRB as well as in the centralizing power of the budget authority and relates them to the change in the fiscal position of the Korean government. Following conclusions emerge.
First, the centralizing power of the budget authority depends, among other things, on the Presidents' trust in the heads of the central budget authority and the budget office. The greater their trust, the better the chance to exclude political influence in budget process and maintain fiscal soundness. In addition, the position of the heads of the central budget authority in the cabinet also affects the effectiveness of budgetary control. When their function is not limited to budget preparation and includes policy coordination between ministries as has been the case in previous governments, the effectiveness increases.
Second, the democratization of the Korean politics has weakened the centralizing power of the executive branch in relation to the parliament. This has generally had negative effects on fiscal soundness. On the other hand, national elections does not appear to have affected the size of the budget or fiscal deficits. However, it gave rise to changes in priorities between expenditure programs, resulting in inefficiencies in resource allocation.
Third, centralization at the implementation stage of the budget is as important as that at the budget formulation and finalization stages. Indiscreet reprogramming across different appropriation accounts or frequent formulation of supplementary budgets can substantially reduce fiscal discipline. Of particular concern are supplementary budgets, which have become more frequent after the recent economic crisis.
Fourth, centralization of the budget process alone, however, does not seem to be a sufficient condition for fiscal soundness. The Korean experience indicates that the centralized budget process should be buttressed by a democratic and decentralized decision-making system within the budget authority. In Korea, the system has been embodied in BRB. The latter has contributed to fiscal soundness by providing a check-and-balance mechanism within the budget authority and by leading it to use its centralizing power for the right purposes - namely, containing the aggregate expenditure growth and maximizing the productivity of limited resources.
In summary, the Korean government could maintain fiscal soundness owing to the centralized budget process and the rational decision-making system within the budget authority. But several changes have occurred in recent years that can reduce the centralizing power of the budget authority in the future. Its head is formally devoid of policy coordination function since the last government. The legislative branch has increased its voice over budgetary policies. Supplementary budgets have become more frequent. With these changes, the risk has increased for us to face more incidences of social dilemmas, in which actions of groups of individuals based on individual rationalities fail to achieve a society-wide rationality. A new strategy is called for to prevent the tragedy of commons from weakening fiscal soundness.
Two policy recommendations are presented in this study. First, centralization of the budgeting process can be strengthened through the adoption of a target-based approach in budgeting. Establishing medium-term goals, such as in terms of fiscal balances or aggregate ceilings on spending, and announcing them in public can help the budget authority in building up a political consensus and maintaining fiscal soundness.
Second, the democratic and rationalist element of the BRB system can be extended to the whole government by strengthening the top-down process in budgeting. Currently, line ministries have little information on the total size of available funds when they prepare their budget bids. Their bids are consequently unrealistically large, which often produces adversarial relation between them and the budget authority. To induce greater rationalism in budget bids, the budget authority should consider indicating the size of funds available to individual line ministries in the Guide to Budget Bids.
It should be noted that this study was able to offer only a partial explanation on the complex relationship between centralization of the budget process and fiscal soundness. In addition, it could not provide firm and quantitative evidence to support major claims. Nevertheless, I believe that this study proposed an interesting hypothesis to explain the determinants of Korea's fiscal soundness.