Changing from Financial Control to Financial Management in the Public Sector: An Introduction to the Changes That Will Be Required

Abstract

Introducing public financial management and internal control (PFM/IC) is a major organisational reform. It has significant managerial consequences, not least on the relationships between elected and appointed officials. Where the reform has been introduced it has frequently been treated as a financial and budgetary control reform but it has far more wide reaching effects if it is to be properly introduced. Not the least of the benefits is that PFM/IC provides an ability to put substance into the meaning of the terms ‘efficiency and effectiveness’ but that in turn requires significant managerial reform. PFM/IC ought to really be regarded as a managerial reform and it is from this perspective that the reform should be viewed. Managerial reform should be the starting point for implementation. Consequently, to achieve success top management commitment to the reform, by both political and senior appointed officials is essential.

This chapter describes the key aspects of public financial management and internal control reform, viewed through a managerial lens. It describes how, without a thorough appreciation of the linkage with management, this reform will at best fail to meet the intended objectives and at worst could add to administrative bureaucracy and hence costs. These are recurrent themes throughout this guide. This chapter introduces some of the terms and facets of the reform that will be explored in more depth in later chapters. Overall, this should be regarded as a major reform and it will take several years to achieve. It affects the quality of policy making, the relationships between politicians and the civil (or local government) service officials, the operational managerial arrangements and the approach to internal control and budgetary and accounting information. To undertake the reform is not a simple task: it has wide-reaching effects including the arrangements for delegation, accountability and transparency. The requirements of the reform may be in conflict with traditional customs and practices and these may affect whether or not the reform can be effectively implemented.

1.1 The Aim of and Audience for This Guide

This guide is about the development and then the practical application of the public financial management and internal control (PFM/IC) reform. It aims to help countries seeking to adopt PFM/IC to undertake this successfully and to avoid common pitfalls experienced by many countries which have tried to adopt PFM/IC, but ended up ultimately with only superficial reforms. The critical pitfall that this guide seeks to highlight and help countries avoid is the common assumption that focusing solely on the technical procedures and bureaucratic processes of introducing PFM/IC will achieve the substantive benefits of the reform. It will not! The technical aspects of the PFM/IC reform are important but to achieve a robust reform, managerial changes will almost certainly be required. Changes to governance arrangements and transparency are also likely to be needed. The nature of the necessary reforms may conflict with traditional custom and practice with the risk that such reforms may be difficult to embed.

Unfortunately, this failure to recognise the impact upon management and traditional custom and practice has been a typical feature of financial management reform activities, both of PFM/IC and other PFM reforms, such as programme budgeting and accrual accounting, leading to some being described as ‘fake’ reforms.¹ A key message of this guide is that countries should do their utmost to avoid this failure. To do that, countries should recognise that introducing PFM/IC requires a major managerial reform and it should be treated as such by senior politicians and senior appointed officials. This guide demonstrates the complexities of the reform.

Before PFM/IC is introduced, countries will have in place some form of public financial administration and internal control (PFA/IC). The principal difference between the two systems is that PFA/IC has a focus on the control of financial inputs, whereas the more advanced PFM/IC has a focus not only on control of financial inputs but also upon the efficient and effective delivery of the outputs of public services. This applies equally to revenue collection arrangements, including taxation. This change of focus is central to improving public sector productivity. With PFM/IC the operational management² of a public organisation has considerably more discretion over the detail of spending (and revenue collection arrangements), that is, the mix of inputs and levels of spending in order to achieve objectives (outputs) and to do so efficiently and effectively, than it would with PFA/IC. Discretion is also needed when circumstances require that economies have to be made so that minimum damage occurs to existing services and activities. PFM/IC consequently has the potential benefit of making the financial system more resilient by being able, through a more effective management, to utilise whatever level of resources are available in an optimum manner.

The aim of PFM/IC is to provide the information and authority operational management requires to deliver the policies of the organisation making the best use of public resources. These policies will be expressed through the budget along with complementary objectives and performance standards. The operational manager’s responsibility is to deliver those policies and objectives efficiently and effectively, to time and within the law and budget. Efficiency and effectiveness apply equally to the utilisation of current resources (i.e., employee costs, supplies and services costs, transport costs and property costs as well as overhead costs) and to the utilisation of assets. It also means ensuring that all resources are only used for public purposes.

Thus, the aim of reform is positive, that is, focussed on achieving the outputs of a public organisation. It is not ‘defensive’ or alternatively negative in concept, that is, simply to impose controls and reduce financial misconduct or misuse, which is how some appear to treat it.³ If the objective of a government is solely to develop or strengthen defensive controls this does not require the extensive managerial reform that would be necessary with the implementation of PFM/IC. The techniques accompanying PFM/IC should be aimed to facilitate, not constrain, managerial discretion. Consequently, in considering this reform this guide advises that, contrary to much advice on the introduction of PFM/IC, countries should start by focussing on and addressing the managerial implications of this reform rather than considering only the technical bureaucratic features. Ultimately, no matter how ‘clever’ the techniques or the bureaucratic rules, without management the benefits of the reform will not be achieved.

The purpose of this guide therefore is to enhance understanding of what a PFM/IC reform is meant to achieve, how to then apply this type of reform and the consequences for managerial arrangements. The key argument is that PFM/IC should be seen as much a management reform, not just a technical audit or accounting reform nor just about improving financial and budgetary control, although if properly applied it will achieve such benefits. It will also facilitate improvements in policy development through the availability of additional information, not least about the causes of the costs of providing services (i.e., those factors that drive costs) or the costs of revenue collection and weaknesses in revenue collection policies.

The guide is predominantly directed at countries either planning or undergoing reform, that is, developing and transition economy countries. However, because PFM/IC has been widely treated as simply a technical financial reform, rather than a management reform even by developed economy countries, such countries which have already been through a reform process would benefit from questioning whether or not they are in practice achieving the benefits of the reform. Not the least of which are improvements in efficiency and effectiveness in the delivery of public services and activities and in the utilisation of assets.

This guide is also aimed at development agencies who often advocate sophisticated reforms when there is little or no local managerial capacity to implement them, much less operate advanced systems. This author has argued elsewhere that “a financial reform must fit with how the state operates’ and that financial reforms are not free standing.”⁴ Yet such reforms are regularly promoted as technical improvements with no recognition of the managerial impact. Where countries are not prepared to make the managerial changes that the PFM/IC reform requires, the reform should not be proceeded with and instead countries should focus upon improving public financial administration and internal control.

Countries considering, or are in the process of implementing, the PFM/IC reform should ask themselves a series of questions which will indicate whether they have recognised the full implications of the reform and not least the managerial impact of the reform? (Table 1.1).

Table 1.1 A self-assessment questionnaire to determine if the comprehensiveness and managerial aspect of PFM/IC reform has been sufficiently realised

If these types of question have not been addressed in planning the implementation of PFM/IC, then there is a real possibility that the resulting reform will not produce the benefits that countries should be looking for and will, in all probability, simply add to costs. Therefore, countries who answer ‘no’ to all or most of the self-assessment questions in figure 1, apart from those marked with a *, should consider revisiting the reform and use this guide to help rethink and adapt how they have implemented, or intend to implement the policy and apply it.

1.2 Why Is Management Relevant and Important?

Development agencies, multi- and bilateral, do often advocate advanced public financial management reforms because they represent ‘international best practice’. Usually, they are treated as technical financial reforms even though they require a managerial capacity if advantage is to be taken of those reforms. Yet there may be limited or even no local managerial capacity to both sustain those reforms on an ongoing basis and achieve the benefits that those reforms make possible. Examples of such reforms include accrual accounting and programme and performance budgeting as well as PFM/IC. Any financial or management reform must also fit with how the state operates including its traditional customs and practices. Reforms are not free standing and will fail or become simply superficial if the promoters of the reform do not sufficiently recognise the context or the complexity of the managerial task in implementing and then delivering the reform into the future.

The reality is that most studies, advice and reform programmes appear to treat PFM/IC reform simply as a financial technique. The discussion contained in such documents makes no reference to the management implications for the utilisation of the technique. This fails to recognise that simply treating it as a financial technique completely overlooks that someone has to apply that technique if there are to be improvements in the utilisation of public resources and that better quality public services result. That ‘someone’ is the manager.

Taking a management perspective recognises that what may be construed initially as simply technical financial reforms actually have a significant managerial impact. For example, line ministry⁵ managers have different information needs so far as budgeting and accounting is concerned from a ministry of finance; managers need clarity of objectives (both operational and performance) and performance standards to work to which can often be difficult to define with any precision, adding to the complexity of the managerial task. This complexity can produce conflicting objectives which in turn need to be managed. For example, what is the purpose of prison: is it retribution, incarceration, deterrence, rehabilitation or elements of all four and is it the same for all prisoners of both sexes? Managers also should be accountable, not just internally but also externally and in particular through parliamentary scrutiny. Accountability is the process that strengthens management through the consequential scrutiny activity. (Parliament may need to establish one or more specific committees to undertake the scrutiny process.)

A misunderstanding about PFM/IC reform, particularly at the political level, is that it is simply about reducing fraudulent or corrupt activity or introducing tighter budgetary and financial controls. The approach to implementation, especially in European influenced countries, has been through focussing on the technical elements of the reform and not least on the financial and budgetary control elements partly because the initial PFM/IC reform activity has been on the development of internal audit. The idea that the reform is also designed to support managers in achieving objectives efficiently and effectively does not appear to be appreciated. The management perspective has been almost entirely overlooked. Delegation and managerial accountability have been developed, at best, principally in the context of financial and budgetary control, not in the context of the delivery of objectives and the achievement of efficiency and effectiveness.

As a result, other features, which recognise the relevance of the reform to management, such as the responsibilities of the different levels of management for the delivery of objectives and for achieving efficiency and effectiveness have been overlooked. Consequently, the need for clarity of objectives (both operational and performance) and performance standards for managers to work to along with the specific financial and performance information that managers require have also been overlooked. Thus, managers should have available to them detailed budgetary information for the area of activity or service for which the manager is responsible; budgets should be consistent with the objectives and performance standards managers are expected to meet. Managers need authority and some degree of control over the utilisation of resources, even over what may be regarded as sensitive resources such as personnel and assets. This in turn requires delegated authority, that is, the ability to exercise discretion. PFM/IC requires strengthening managerial discretion. Management structures need to be so organised that they secure effective management of the different elements of a service or activity with mechanisms to enable managers to be held to account by more senior operational managers leading to accountability to the political management of an organisation. Those managerial accountability arrangements have to be effective and that means that those more senior managers must respond to accountability reports. Ultimately, reporting should be to parliament as part of the government responsibility to demonstrate how budgetary resources have been used. Two forms of parliamentary scrutiny could occur, one which responds to the report of the state auditor (sometimes by establishing a committee perhaps called a ‘public accounts or public audit committee’) and the other which investigates the quality of the management of public resources which again can be undertaken through a parliamentary committee arrangement.

1.2.1 Management

The question then is, who is the operational manager and what is the environment in which that manager is operating? The manager barely gets a mention in most reform strategies, because of the focus upon PFM/IC as a financial control technique. Neither does management training apart from the notion that somehow training in the technique will solve all problems. Yet success with this PFM/IC reform depends upon the information the manager has available and upon the capacity of the manager to use that information.

However, for public sector organisations a difficulty can be determining who is the manager? Is the manager the minister or mayor or other political head of the organisation, supported by their deputies or in Francophone countries by a politically appointed cabinet? Is such a person responsible for policy development, policy implementation and operational management in the delivery of public services? Or, is there a distinction between a minister or mayor responsible for policy and strategy and a civil or local government service responsible for policy implementation and operational service management, as occurs, or should occur, in Anglophone systems? In most systems the politically appointed head will have overall responsibility for the successes and failures of the organisation but may not have day-to-day responsibility for operational management (i.e., policy implementation). In such circumstances the political head is likely to have a responsibility to supervise the quality of the operational management ensuring that it delivers the policy objectives and maintains budgetary and other controls. In many countries adopting PFM/IC, the managerial situation is quite unclear and the law often refers to the responsibility for the implementation and quality of PFM/IC as that of the ‘top manager’ by which is meant the political head of the organisation. As is shown later in this guide, this is not a practical arrangement with the implementation of PFM/IC unless accompanied by operational management reform.

In Anglophone systems there is, in theory, usually a clear distinction between the responsibilities of the political head of the organisation and the administrative head. The latter should be responsible for policy delivery and operational management. The administrative head is very often known as a permanent secretary. Permanent secretaries are the ‘accounting officers’, meaning that they are responsible for ensuring that public funds allocated to the ministry through the budget process are appropriately spent. The permanent secretary is responsible for the application and quality of PFM/IC within the ministry. This official can be called to account by parliament as part of the parliamentary scrutiny process. However, a constitutional convention is that a cabinet minister bears the ultimate responsibility for the actions of their ministry or department. This means that if an administrative failure occurs within a ministry, the minister is responsible even if the minister had no knowledge of the actions which led to that failure. In other countries this distinctiveness in the allocation of responsibilities is not so clear and the political appointee may be responsible for both policy and day-to-day operational management and this results in some countries in the minister undertaking minor administrative tasks.

A feature of the implementation of the European Commission’s version of PFM/IC which is called ‘public internal financial control’ (PIFC) and which is to be applied by countries wishing to join the European Union or benefitting from its funds as neighbourhood countries is the recognition of a need for delegation and the corresponding development of accountability. This ought to mean the delegation of operational management responsibility from the political to the civil service (or local government service) level. But in practice because the reform is treated as a financial technique, delegation is usually limited to aspects of financial control and relatively minor administrative matters.

A manager is defined as a person responsible for controlling or administering the whole or part of an organisation or group of staff.⁶ Managers ought to exist at all levels in an organisation and a clear management structure should exist. Managers at different levels within an organisation should have different levels of responsibility and these will be, or ought to be, set out in delegation arrangements. Each level of management should be accountable to a higher level of management and ultimately to the top manager, whether a political figure or an official. Where operational management is the responsibility of the civil or local government service, a state secretary (or equivalent), or head of a local government service, would be the top operational manager and therefore responsible for the application of PFM/IC. That top operational manager should be responsible for the quality of operational management including the delivery of objectives and performance standards efficiently and effectively and to time and for the control of income and expenditure to within budgetary limits. In turn that top operational manager should be responsible for the quality of operational management to the political manager.

Success with the application of PFM/IC depends very heavily upon the quality of management but changing the role and responsibilities of civil servants and local government officials to incorporate managerial responsibilities does not somehow automatically make them effective managers. Good quality managers in most public sectors are in short supply, and therefore, countries embarking on the PFM/IC reform should recognise that a heavy investment in management training is likely to be required. (Who is the manager is also discussed in Chap. 2.)

A schematic representation of the arrangements that ought to apply with the implementation of PFM/IC is set out below:

1.2.2 Leadership and Organisational Culture

The leadership responsibility in the development and application of PFM/IC would in most countries fall upon the minister of finance, and the responsibility of that ministry would extend to ensuring that the application of the PFM/IC policy in individual public organisations followed the specified policy guidance. There should be overall government support for the reform and head of government (prime minister or president) support as well as that of the cabinet of ministers is necessary. Parliamentary support for the reform is also essential, and this should include parliamentary approval to the reform itself and the process for implementing the reform. Parliament should also be informed periodically of implementation progress.

Overall responsibility for operational implementation leadership of PFM/IC for the public sector should lie with the head of the civil service in the ministry of finance (the state secretary or equivalent). Responsibility for the leadership of the operational application of the reform within each ministry or other public organisation should lie with its head of the civil or local government service under the guidance of the head of the civil service within the ministry of finance. (In some countries there is no single civil servant who has the role of ‘head’ within a ministry: where this is the situation with PFM/IC this arrangement will almost certainly require change as this guide demonstrates.)

Delegation of operational management and managerial accountability are not only key features of PFM/IC but they are essential to make PFM/IC work, as this guide will show. However, for some countries the introduction of delegation and managerial accountability will represent a radical cultural change. Politicians who have traditionally been responsible for operational decisions as well as policy development and the strategy for the application of that policy may find such a change difficult to accommodate because it runs against traditional cultural approaches. This will be a factor in the extent to which PFM/IC reform is possible, and certainly, it will affect the timetable for implementation.

This distinction between policy development and operational management must be addressed by the political and civil service leadership responsible for the implementation of PFM/IC. This is because, if properly applied, PFM/IC is about the professionalisation of operational management, and a minister or mayor will find it impossible to remain responsible for both operational decision making and policy and strategy development. This is because of the demands that PFM/IC will make upon the time and skills required for efficient and effective delivery of operational objectives and performance standards. (However, effective policy development and the strategy for its application depend very heavily upon cooperation between the politician and operational management for it is the latter who has, or should have, the experience and information necessary to turn political ideas into operationally effective public services.)

The features of PFM/IC affect the way in which an operational manager would carry out a particular task and therefore the operational manager must become familiar with them because they impact upon the achievement of objectives and improvements in efficiency and effectiveness. They have the potential to generate public service improvements, better quality policy making (because more information should become available) and more efficient resource utilisation. However, they will not do so unless they are accompanied by a managerial capacity to take advantage of them. Failing to recognise the importance of management and simply focussing on techniques (which usually are simply defined as the international standards⁷ and the bureaucracy associated with those standards), which appears to be almost always how PFM/IC is developed, will not achieve the benefits that the reform can bring. It simply adds bureaucracy and hence costs and can have a negative effect on morale as well as upon the possibility of other future reforms if no benefits become apparent. Not recognising the managerial changes PFM/IC requires and simply focussing on these techniques will not cause public services and activities to be delivered more efficiently and effectively. Yet an important objective of all PFM/IC reform is to improve service delivery, the achievement of objectives along with improved operational efficiency and effectiveness and asset utilisation.

Another critical factor that is frequently overlooked in the introduction of PFM/IC reform is the extent of cultural change required within organisations. Such change is not simply about reforming the organisational structure but is also about changing human behaviour and the relationships between different organisations such as between a ministry of finance and spending (line!) ministries. With PFM/IC spending ministries should have more discretion to make decisions within a context set by a central ministry such as a ministry of finance. This in turn raises the question of ‘trust’, that is, will a central ministry ‘trust’ a spending ministry to utilise its resources efficiently and effectively? Similarly, the delegation of operational management to the civil service requires civil servants to make decisions and consequently to take risks. Will the political level ‘trust’ the civil service to do that? Another feature of the reform affecting culture and behaviour is leadership. How the leader performs and the attitudes of the leader can be significant in the successful implementation of the reform and in its subsequent operational application.

However, in many countries there is a problem with requiring the head of the civil service in a ministry or other public organisation, to undertake the leadership role in the implementation of PFM/IC. This is because in many countries the law provides that the organisation leader is the top political official who is directly responsible for all activity and therefore feels that he/she must make all decisions. This person should have ultimate oversight of the implementation of the reform but that is different from having responsibility for day-to-day implementation. In countries where the operational management leader is a permanent, rather than elected, official, such as a state secretary, whilst a politically appointed official can influence the culture and managerial approach of the organisation, there is a potential to maintain a continuum in the approach (although this may be ‘good’ or ‘bad’). Political change may cause policy and strategy change, but where there is separation between responsibility for policy development and operational management, political change does not necessarily affect how operational management is conducted. Operational management needs to remain stable for successful sustainability of the reform. In addition, the requirements falling upon the top official with PFM/IC are such that an elected official would not have the time or the training to undertake all the managerial responsibilities that would flow from the reform.

The cultural change that introducing PFM/IC will cause requires the support of the political leadership. Because that cultural change will cause civil servants to make managerial decisions, they will need to be prepared to take risks: all decisions involve some element of risk. This is a factor which will affect the willingness of civil servants to take decisions because in many countries there exists a fear of personal penalty for error of judgement or mistake or even of making a potentially controversial decision. So, in introducing PFM/IC, consideration should be given as to how these penalty arrangements will impact upon the attitude and approaches of civil servants.

Almost inevitably change induces resistance amongst some and a feeling of ‘this is not how we do things here’. Again, this impacts upon operational leadership, and the question then becomes how can the operational leadership arrangements have a positive impact on the changing culture of an organisation? Such issues are rarely, if ever, considered as important to the success of PFM/IC reform. The positive commitment of the head of operational management is essential as is management training for the different levels of management. Usually, any training that is provided is concerned simply with technique in terms of applying the bureaucratic requirements of PFM/IC and this is regarded as all that is necessary. The application of a sophisticated reform such as PFM/IC requires the application of sophisticated management and a thorough review of how organisations are managed and the training available to managers. This applies equally to the penalty and reward structures applying to management. Management training and the impact upon human relations (HR) policies are often overlooked in the reform process with the only staff management concern being expressed is through ‘training in technique’.⁸

1.3 Key Terms and Facets of PFM/IC Reform

The technical aspects of PFM reform are covered in many text books and handbooks on the subject (e.g., ‘Financial Management and Control Manual’⁹ and PIfC¹⁰). However, they rarely, if ever, describe the critical role the manager needs to play in each of the technical areas. They do not discuss the role of the leader or the distinction between policy and strategy development and operational management. This section highlights some of the key terms and facets of PFM/IC reform that will be explored in more detail later in the guide and highlights the managerial versus the technical aspect of the function.

1.3.1 The Budget

A precondition for PFM/IC reform is that the budget provides a clear and reliable basis on which management can build the policies, strategy and objectives that an organisation aims to achieve. The budget, as far as possible, should be consistent with the objectives (and performance standards) that an organisation is expected to achieve. The individual managers within an organisation should be involved in the budget preparation process and agree that the objectives (and performance standards) they are expected to achieve can be delivered within that budget. Where the overriding consideration is the level of the budget, if that is insufficient in the view of the manager to deliver the objectives and performance standards, then either the objectives or the performance standards or both should be modified to fit with budgetary availability or the budget should be adjusted to ensure that there is compatibility.

With PFM/IC the disciplines surrounding the budget should be such that manipulative activities to avoid budgetary and financial controls should be eliminated as far as possible. Budgetary discipline is particularly important because for managers to deliver objectives and performance standards within a specified budget efficiently and effectively adds significantly to the pressures upon them compared with simply ensuring that spending does not exceed a specified budget. This means that ideally there should be no scope for public organisations to avoid the budgetary limitations by, for example, transferring items of expenditure between revenue and capital (or investment) budgets or by using second-level bodies such as agencies or state-owned companies to incur expenditure as proxies for their controlling or owning first-level public organisations or by transferring payments between years. Again, there should be no scope for moving expenditure apparently into the private sector through ‘off-balance sheet’ arrangements, leasing and other similar devices¹¹ or for using extra-budgetary funds except within very clearly specified circumstances. This should extend to use of ‘own funds’ generated by either first- or second-level organisations. With PFM/IC a risk is that the added pressure on managers to deliver objectives efficiently and effectively may cause managers to try to avoid the impact of budgetary and financial controls. This imposes an added responsibility on ministries of finance to ensure that budgetary and financial controls are rigorously observed.

The budget also provides the key financial mechanism by which parliament exercises financial control. In addition, a question that will need to be considered is the extent to which the traditional budget, and in some countries the budget law, should be modified to include objectives and performance indicators. PFM/IC enhances the opportunities for parliamentary scrutiny. In other words, PFM/IC potentially increases transparency and public accountability.

1.3.2 Cash Management

Budgetary control rules will be complemented by cash management rules. A ministry of finance will want to ensure that it is not forced to borrow unnecessarily through unplanned or erratic expenditure patterns or revenue forecasts that cannot be fulfilled. With PFM/IC the flows of expenditure will affect the ability of the manager to deliver efficiency and effectiveness and therefore managers should be consulted about cash flow calculations and they should not simply be determined by the interests of the ministry of finance.

With PFM/IC the operational management will have much greater scope for decision making than they would with PFA/IC. This includes having automatic authority to spend (subject to any overriding or specific constraints) with only managerial approvals as necessary within their organisation but without further ministry of finance approval. Managers must also respond to changing circumstances especially as they will be expected to deliver objectives and this could affect the traditional arrangements for the approval of budgetary variations (virement). All of this should affect attitudes to cash management controls which in practice will mean that such controls should become more strategic rather than detailed.

1.3.3 Management Accounting

Managing the budget of a public organisation to deliver objectives to time, to standard, efficiently and effectively is no simple task and it requires highly trained and financially aware managers. The operational manager needs to understand what causes costs to be what they are, that is, what drives costs, and which parts of the organisation are operating efficiently and effectively and which are not. This is a contrast with administering a budget within the context of a PFA/IC regime where the administrator’s task is much more limited to ensuring compliance with the ministry of finance external controls. What this also means is that both budgets and financial information need to be allocated in accordance with the needs of the manager, not solely in accordance with the needs of the ministry of finance.

The development of management accounting therefore should be a feature of this reform. Management accounting responds to a manager’s requirement not only for different budgetary and financial information for effective management from that required by a ministry of finance, which has different interests from the manager. What are also required are systems which deliver performance information and which need to be linked to the management accounting system. This linkage should affect the construction of the budget as well as the type of financial analysis the manager should require. The form of analysis that suits a ministry of finance is rarely likely to meet the needs of the manager, especially where the manager is responsible for delivering efficiency and effectiveness and service quality. This involves a challenge to the traditional practices and controls exercised by a ministry of finance. It also requires the development within public organisations, other than a ministry of finance, of more sophisticated financial analytical systems and the capacity of organisational financial analysts and managers to utilise those systems. This in turn raises questions about the capacity of finance officers within organisations. Do they have the training to provide the information that managers require? These requirements are not simply those of financial controller and bookkeeper¹² but managers will require financial analytical information and that a capacity exists to provide advice and support including over the implementation of policy, the strategy for the implementation of that policy as well as over the development and implementation of investment projects. These are not skills that are readily available within governments and require the employment of professional, that is, more expensive, staff. A question then is how are such skilled persons to be recruited, used and integrated into existing career structures? Integration is important because such skilled professionals need to become ‘part of the team’ and not perceived as ‘outsiders’.

1.3.4 Control

The term ‘control’ has a wide range of meanings. These can range from ‘prohibit’ to ‘manipulate’, and within this range there are two major themes. First, there is the idea of control as ‘domination’. Secondly there is the idea of control as ‘regulation’.¹³ Both meanings can exist within the use of the term in the PFM/IC management arrangements.

Advisers and others promoting PFM/IC sometimes talk about ‘control’ in terms of ‘lines of defence’ focussing on ensuring that public resources and assets are not misused through fraud or corrupt activity.¹⁴ This often occurs where internal audit has been developed before PFM/IC and the ‘policy focus’ is dominated by internal audit concerns. This is quite appropriate if the only concern is financial and budgetary control which leads to a robust public financial administration. But the result is not financial management. It also makes the mistake of focussing control on adherence to procedures and budgetary compliance not recognising that bringing together public financial management and internal control broadens the meaning of internal control to include the management controls necessary to secure the achievement of objectives and to do so to time, to standard, within budget, efficiently and effectively. The issue for management is how to ‘control’ (a better term might be ‘steer’) the organisation to ensure that it delivers its objectives and at the same time makes the best use of resources. This is not about defence. This is achieved by deciding upon the best strategy that will achieve success and that strategy will depend upon how best to utilise all the resources that a government has available for a specific purpose and how to do so efficiently and effectively. Delivery of that strategy depends upon the quality of management and that is why the focus of PFM/IC is upon ‘management’ and its ability to achieve its objectives. Merely thinking about control in terms of ‘defence’ will not achieve that.

1.3.5 External and Internal Control

The development of PFM/IC has the consequence that detailed financial and budgetary control shifts from external control to internal control. This means that instead of an external organisation such as a ministry of finance or a state auditor or some other external body, that is, external to the ministry or other public organisation, approving expenditure and ensuring that spending does not exceed approved budgets or that personnel appointments and procurement arrangements conformed with externally set regulations, such controls would be exercised by the management of the public organisation itself. This is characteristic of moving from an administrative style of public service organisation to a managerial style. Thus, the organisation management would act as the controller, albeit exercising that control according to centrally agreed rules and it would be accountable for how it had applied those rules. The benefit of this is that it facilitates the exercise of discretion by the management of an organisation and therefore creates the opportunity to improve efficiency and effectiveness in the utilisation of public resources. This element of the reform is counterbalanced by enhanced arrangements for managerial accountability. Professor Allen Schick argued in 1978 in an article on Contemporary Problems in Financial Control¹⁵ that the evolution from external to internal control was a ‘sea change’ in financial systems, that is, “Internal control is much more than a procedural matter. It represents a fundamental shift in attitude about government. In an era of big activist government, internal control signifies that public agencies can police themselves, that it is much more important to get on with the job than to worry about preventing the misuse of funds.” Therefore, where a country wishes to implement PFM/IC it does need to ask itself this question: Given the growth in the scale of public services with the growing demand for more and better quality services can we continue to administer those services in the same manner that we have always done and still achieve the objectives of public expenditure, or do we need to rethink the administrative arrangements? The substantive introduction of PFM/IC, that is, with a managerial perspective, raises this question. It also adds to this question by asking, what is the purpose of the control? Is it simply budgetary and financial control to maintain a traditional and tight control to meet the particular needs of the ministry of finance (and other central ministries) or should the control reflect not just those needs but also those of the manager required to help the manager achieve objectives and performance standards? Managerial control needs are likely to be different from those of a ministry of finance because a line manager may require greater flexibility in the management of budgets in order to deliver objectives and to make improvements to efficiency and effectiveness: a ministry of finance is in no position to do either of these. To reconcile the ‘control’ interests of a ministry of finance and a manager, a necessary parallel reform should be to establish a different approach to the external control framework of regulations and guidance so that it focuses on strategic issues rather than on the detail. Reform also needs to occur to the budgeting and accounting arrangements. Such a reform would allow budgetary and accounting information to be analysed in a manner that suits two sets of needs, that is, those of the manager and the ministry of finance. No longer should a ministry of finance have a monopoly on how such information should be presented. This will require the development of more sophisticated data analytical arrangements.

Another feature of effective management is how well managers cope with austerity. Periods of austerity are almost inevitable and the challenge for managers in such circumstances is how then to continue with the highest possible level of service delivery. It is not simply a matter of ‘cuts’ but of prioritising services, seeking out inefficiencies, disposing of underused or surplus assets and rethinking how services can be delivered within a constrained financial envelope. Again, line ministry managers are more likely to be effective in managing austerity at the individual service level than the ministry of finance, emphasising again the significance of internal control being exercised by the organisation management.

Whether or not such a change from external to internal control could or should occur or be achieved depends upon the quality of the existing public administration arrangements. It also depends upon the level of trust that exists between the political and the official levels of the public administration and between a ministry of finance and other central ministries and line ministries and other public organisations. In some countries, such trust does not exist and results in the politicisation of the civil or local government administration with a reluctance to offer any concessions on control by central ministries. This lack of trust, in turn, encourages elected officials to see their role as including that of operational management, sometimes at a very detailed level.

‘Trust’, which needs to exist at all levels, is not just trust that ‘inputs’ are controlled but that the ‘outputs’ meet expectations compared with those ‘inputs’. Those expectations though need to be explicit rather than implicit. ‘Trust’ is a product of the professionalism of the management.

Another factor is that central ministries may also be very reluctant to lose their powers to exercise detailed control. An example of central ministries wanting to maintain central control is that given by De Geyndt referring to devolution of responsibility to hospital management in low- and middle-income countries with the aim of making their hospitals more performing, that is:

Policies granting autonomy to public hospitals have had limited success. In all cases Boards of Directors have been created. Governance of autonomized hospitals by Boards however is obstructed by the resistance of central level entities to have their authority diminished. The Ministry of Finance tends to maintain control over revenues and expenditures. The Public Service Commission resists abdicating its role to hire, promote, transfer and dismiss government employees. The Ministry of Health attempts to keep its authority to appoint hospital staff, procure medical supplies and equipment; it may do so directly or indirectly by selecting and appointing Board members. Management information systems continue to collect activity measures to be aggregated at the national level for statistical purposes and do not provide financial and clinical data useful for decision making by the Boards and by senior management.¹⁶

Also attempts to establish sophisticated systems of public financial management, including PFM/IC, when existing systems of public financial administration are weak, are mistaken. Examples of public financial management reform failures are given in a research study ‘Evaluation of Public Financial Management Reform’.¹⁷

Weakness in public financial administration is identified by extensive levels of corruption and fraud, weak budgetary and financial controls or poor application of such controls, by lack of trained and experienced civil or local government staff and by instability in staffing arrangements, often demonstrated by political interference in operational management because of a lack of trust. This in turn prevents the development of the ideas of ‘delegation’ and ‘managerial accountability’, both of which are essential to the establishment of PFM/IC and management more generally. In such circumstances introducing sophisticated systems which, if they are to work, means giving more discretion to individuals without a strengthening of accountability. This will only exacerbate current problems, not lead to their solution. This point about building quality before switching from external to internal control has been made by Stephen Peterson in his book on the lessons from Ethiopia’s 12-year reform¹⁸ “A coherent financial reform requires an alignment of the purpose of the financial reform, building financial administration or management, with the operation of the state, administration or management. A principal and possibly key reason that financial reforms have failed in developing countries, especially Africa, has been the attempt to insert financial management into states that have weak administration.” As Professor Peterson says, “How can you build a sophisticated financial management system onto a weak public administration system?”

1.4 Implementing Reform from a Management Perspective

Looking at the implementation of PFM/IC from a management perspective this raises a specific set of issues that need to be considered. These are discussed in the following sections.

These are questions that the top management (ministerial and state secretary or equivalent in local government) together ought to be asking and they involve cooperation between political and operational management. They apply equally to both expenditure and income.

• 1. How do we best deliver the policy and the objectives we are expected to deliver;

• 2. How do we deliver those objectives to time, to standard and within budget;

• 3. How do we deliver those objectives efficiently and effectively;

• 4. Is the present organisational structure appropriate for the purpose;

• 5. Do we have an appropriately skilled management and workforce;

• 6. Do we have the necessary resources and information, financial and performance;

• 7. How do we ensure that public resources, including assets, are only used for approved public purposes;

• 8. How do we ensure financial resilience for the organisation, not just for the current year but into the medium and longer term;

• 9. Are the accountability arrangements clear and effective, both internally and externally?

The order of the importance of each of these questions and which element of management has the most interest in them lies with the circumstances that prevail in each country seeking to introduce PFM/IC. Failure to approach this reform in this manner will affect its success. In answering these questions, the top management, both political and official, also need to ensure that the culture prevailing in the organisation is one that is focussed upon the interests of the user of public services; that those to whom authority is delegated are prepared to accept the conditions of delegation and accountability and that the operational environment enables them to do so. The public interest should be paramount.

These managerial elements of the reform process are not addressed just by the technicalities of PFM/IC. They need to be addressed as part of the processes of a public administration reform leading to a focus on management. (The relationship between the PFM/IC reform and public administration reform is discussed in Chap. 14.) That such a public administration reform should occur and ideally precede a PFM/IC reform is essential as part of the preparation for the introduction of PFM/IC. A PFM/IC reform cannot be used to drive managerial reform: managerial reform needs to come first. As the PFM/IC reform requires a high degree of managerial skill the reform should not be entered into without a full appreciation of what will be required in terms of managerial capability as well as the extent of the technical reforms that will be required.

If the argument is that the civil service/local government service does not have that capability, this in fact raises the whole question as to whether a PFM/IC reform is appropriate anyway. Introducing the PFM/IC reform without civil and local government service reform, unless it already has a managerial capacity, is a mistake. A consequence, if the reform is to go ahead, is that the reform will take much longer to implement with the risk, even likelihood, that the benefits will not be achieved. However, the reality is that this is what frequently occurs. (Personnel development is discussed in Chap. 14.)

Planning the implementation of PFM/IC, as is shown above and in later chapters of this guide, should recognise that there are a series of important strands that need to be addressed to accommodate both the managerial and financial changes that accompany the reform. These include

• an emphasis upon managerial decision making within the delegated parameters designated for each level of management, to achieve objectives efficiently and effectively and within budget;

• a reconsideration of the relationships between central and line ministries to facilitate decision making at the line ministry level whilst retaining overall financial and budgetary control;

• reform to the budgeting arrangements to provide the information managers require;

• development of the financial and performance information that managers will require including the development of cost and management accounting;

• reform to the information technology systems (IT), both to extend their use and to amend current systems to make them ‘managerially friendly’;

• the development of accountability and transparency arrangements and encouraging parliament, interest groups and users of public services in reviewing performance to bring together finance and outputs and for parliament to develop a capacity to consider budgets and reports not just in terms of financial inputs but also in terms of expected and actual outputs.

Because PFM/IC represents such a radical managerial change the cultural environment in which decisions are made also needs to change because this creates new risks. This is addressed in Chap. 6.

A crucial element of this reform should be to create a civil and local government service that has a capacity to advise ministers (and mayors) on policy issues based upon their experience of operational management and to deliver public services efficiently and effectively within budgetary and legal specifications and the politically determined policies.

Also, citizens want to see that public funds (their funds!) are well spent and that legal and regulatory rules are adhered to. Managers and policy makers do not have a monopoly of wisdom over decisions about service levels and there is an increasing trend to encourage public participation in decision making processes including in the budget process. The benefits have been summarised in this way:

Good public participation practices can help governments be more accountable and responsive to their communities, and can also improve the public’s perception of governmental performance and the value the public receives from their government. Transparency is a core value of governmental budgeting. Developing a transparent budget process will improve the government’s credibility and trust within the community.¹⁹

The solution to public sector problems frequently requires reliance on several public organisations coordinating their activities. It may also require coordination with private organisations. A single organisation thinking that it can alone solve a social or other form of public problem (such as the alleviation of homelessness), that is, a silo mentality approach, can be mistaken. Yet very often individual ministries are allocated specific responsibility even though an effective solution depends very heavily upon utilising the resources and expertise of other organisations. A feature of PFM/IC is information and coordination and that just does not mean within an organisation but more widely. This again is a management responsibility and is not simply addressed by thinking only in terms of budgetary and financial control within a single organisation. Management needs to consider this wider dimension in preparing budgets and in the form of the accounting and performance arrangements that will be necessary to enable managers to maintain control and determine how well they are achieving their objectives and very often in cooperation with managers from other organisations. This again raises the question of how such operational service coordination that can be required over time can be best achieved. That coordination may be essential in considering how to achieve efficiency and effectiveness.

However, preventing the development of a ‘silo mentality’ can be extremely difficult. Programme budgeting is in theory a solution to this problem but programmes are frequently just focussed on individual ministries with line ministry managers reluctant to share budgets with other organisations.²⁰ A ministry of finance can exercise pressure to encourage budget sharing but, in practice, to be successful a cabinet decision led by the prime minister (or in some countries by a president) with parliamentary support may be essential.

1.4.1 Longer Term Public Financial Management

In many countries, whether operational management is the responsibility of political or civil service officials, public services and activities are not managed but are administered in accordance with traditional practice. This means that the focus of financially based control is on spending the items of the current year’s line-item budget with little or no regard to the longer term even where medium term budgeting exists. Also, no practical regard is had to how to improve efficiency and effectiveness as part of the administrative arrangements even though often budgetary announcements may be coupled with expressions of intent to make such improvements in public service delivery. However, most public sector objectives along with improvements in efficiency and effectiveness cannot be achieved within a single year or even a medium-term time horizon of a three- or four-year budgetary period. Effective management of public services requires that regard should be had to the longer term time horizon over which objectives may be achieved along with improvements in efficiency and effectiveness. This is not about multi-year budgeting but is about establishing a longer term financial perspective of the costs of implementing public policy in providing particular services. That longer term financial perspective is necessary for a better quality of budgeting. That financial perspective is likely to reach beyond the conventional three- or four-year period of medium-term budgeting. Longer term budgeting is also not a simple projection forward of existing budgets and allowing for inflation. It needs much more extensive analysis. Effective management requires that an organisation has a capacity to prepare long-term financial forecasts reflecting all circumstances such as the ongoing future costs of current policies and investments as well as the factors that are likely to affect those future costs and the ongoing financial resilience of the organisation. These other factors would include the financial impacts of, for example, changes in the population, legislation, technology, in the environment, including climate change and so on. Only then can management prepare longer term service plans where the impact of potential ‘shocks’, such as budgetary limitations, on service delivery can be properly assessed. If such longer term analyses are not made, those responsible for service delivery can then be forced into short-term ‘service cuts’ to accommodate unforeseen events which are almost inevitably uneconomic and damaging to service delivery. Longer term financial forecasting, which may cover any period from three to ten years (depending upon the service concerned such as its capital intensiveness) is an important factor in achieving greater efficiency and effectiveness in service delivery and is an important element in the development of PFM/IC. Again, this is frequently overlooked in its implementation or if forecasting is attempted it is treated as a token type of exercise.

Another feature of longer term public financial management is the long-term financial resilience of a public organisation. Political management should be advised by the civil or local government service against making policy or investment decisions which are unlikely to be capable of being financed over the longer term. That way leads to a lack of financial resilience or an inability to continue with the present patterns and standards of service delivery or, for say a local government. an inability to remain solvent. (The financial perspective of a state secretary (or equivalent) is always likely to be longer than that of a politically appointed official and this should be reflected in how a state secretary considers the financial viability of an organisation.)

1.4.2 Ownership of the PFM/IC Reform and Stability in the Reform Process

Another factor which is frequently not considered is the ownership of the PFM/IC reform and stability within that ownership. This is also an element in the cultural issues that were referred to earlier. ‘Ownership’ raises the question, whose reform is it and that in turn affects its acceptability? Is it an externally imposed reform as part of a financial aid package (bearing in mind that the motives of the providers of financial aid packages are not necessarily the same as those of the recipient government)? Or, as for European countries, is adoption of the reform a condition of membership of the European Union? Is it a reform wholly embraced by the government itself or only by the ministry of finance? Within individual government organisations the question becomes, is it a reform that a ministry or local government itself wishes to see implemented or is it to be imposed by an external organisation such as the ministry of finance. And within that as the reform is applied who becomes the ‘owner’ within individual organisations?

There is also the question of the overall owner within a government. Usually this is the minister of finance but whether this is a sufficiently high level of ownership depends upon the status and experience of the minister of finance and of the ministry of finance. If that minister does not have a high status within the government, to be successful the overall owner might have to be the prime minister, whose support is essential anyway. High-level ownership is essential to successful implementation.

Externally imposed reforms have much less chance of being successful in the longer term, especially where the benefits cannot be perceived. This is because they are lost in the bureaucratic arrangements which often occur with such reforms (not least with public financial management reforms). Equally, even if reforms are externally imposed, there does need to be a ‘local owner’ and leader who is sponsor of the reform within the organisation. The question then is who is that to be? This in turn raises the question of consistency. If the ‘owner’ or leader changes frequently, as is possible when the owner or leader is a political appointee, can consistency of policy be maintained and maintained continuously? At the individual public organisation level, such as line ministries and local governments, ownership ought to lie jointly with the political leadership and the civil service or local government official leadership. Civil service or local government ownership is essential where operational management is their responsibility. The technical aspects of PFM/IC do require considerable technical knowledge and the owner must also have considerable persuasive powers to secure implementation within large and complex organisations (as ministries and larger local governments are).

Similarly, a minister of finance or the state secretary within that ministry will need to persuade key officials within the ministry to accept the implications of the reform for that ministry. For example, the head of the budget department will need to be persuaded that the budgetary arrangements should be redesigned to meet the needs of the manager as well as those of the ministry of finance and similarly with financial information. Again, persuading the department or ministry responsible for personnel to recognise the need to allocate personnel costs in a manner which promotes effective management may also prove difficult. Also, persuading those responsible for determining salary structures to recognise the enhanced role of the head of finance and finance department staff and hence to attract appropriately trained and skilled personnel may prove difficult. (Not the least of these reasons for difficulty will be that they upset traditional arrangements.)

Achieving ‘ownership’ and its continuity are among the most significant challenges to be faced by those responsible for the application of this reform, yet they are usually never considered where the reform is treated as a technical bureaucratic reform ignoring all these managerial and cultural implications. Or where the pressure for reform comes from external organisations such as providers of aid, the driver of implementation is likely to be the donor rather than an ‘internal’ owner. Neither of these approaches will lead to success in terms of achieving the benefits of the reform.

1.4.3 Corporate Governance (or ‘Good Governance’)

Corporate governance is rarely considered in the process of introducing PFM/IC. This is even though an essential feature of the reform is promoting good governance, including transparency and accountability. Corporate governance has been defined as being about the way in which public organisations are directed and controlled. The design of the structures of governance within organisations and not least between political and appointed officials and between first- and second-level organisations should have regard to the requirements of corporate governance. A failure in such relationships can lead to serious adverse consequences.²¹

Accountability is an important feature of corporate governance and associated with accountability is transparency. Transparency is a key factor in developing ‘trust’. There are two elements to accountability. One is internal accountability. A need for operational management accountability as an essential element of the PFM/IC reform is widely accepted. It should demonstrate how efficiently and effectively objectives and performance standards have been delivered to the senior and top management of an organisation. A second is accountability to external interests, that is, external to organisations such as parliament, to the service user and taxpayer, that is to civil society. External accountability, particularly to parliament, has been referred to earlier in this chapter but is usually not considered in PFM/IC reform proposals. A fear appears to be that external accountability exposes governments to criticism and risk. Yet, transparency and accountability enhance the benefits from the implementation of PFM/IC as the following quotation demonstrates: “International experience, from research, … show(s) that there is a strong positive correlation between accountable and transparent political and economic institutions and the sustainability of the development outcomes.”²²

Corporate governance should be therefore a factor that the government, the minister of finance and ministers and mayors as well as senior civil service and local government officials should take into account and incorporate into guidance on the application of PFM/IC.

PFM/IC, if properly implemented, improves the quality of governance because it makes clearer who is responsible for what. It also causes the distribution of responsibilities through the introduction of delegation accompanied by managerial accountability arrangements, so that those responsibilities are no longer focussed wholly upon a single or very few senior, usually political, officials. Because PFM/IC encourages the separation of policy decision making and the strategy for implementing those policy decisions from the actual execution and operational decision making, it gives to top and senior management more time to focus on strategy and policy and hence potentially improve the quality. It also potentially allows operational decision making to occur at the level of an experienced operational management. This is because through delegation, operational decisions are more likely to be made by persons (civil or local government officials) who should have longer operational experience of a service or activity than elected officials whose tenure in office can be limited and often they will have no practical experience in the delivery of the service or activity for which they are responsible. Separation of operational decision making also allows operational decision makers to focus on the operational considerations rather than being influenced by political considerations, although such considerations may influence operational decisions.

Governance also includes the arrangements put in place to ensure that the intended outcomes for stakeholders, who could include service users, taxpayers and other interested parties (i.e., civil society), are defined and achieved.

An international framework²³ describes the fundamental function of good governance in the public sector as being to ensure that public organisations achieve their intended outcomes while always acting in the public interest. This framework further defines what acting in the public interest means, that is:

Acting in the public interest requires:

A. Behaving with integrity, demonstrating strong commitment to ethical values, and respecting the rule of law.

B. Ensuring openness and comprehensive stakeholder engagement.

In addition to the overarching requirements for acting in the public interest in principles A and B, achieving good governance in the public sector also requires effective arrangements for:

C. Defining outcomes in terms of sustainable economic, social and environmental benefits.

D. Determining the interventions necessary to optimise the achievement of the intended outcomes.

E. Developing the entity’s capacity, including the capability of its leadership and the individuals within it.

F. Managing risks and performance through robust internal control and strong public financial management.

G. Implementing good practices in transparency, reporting and audit, to deliver effective accountability.

1.4.4 The Timing of the Reform

Because introducing PFM/IC is a major reform, there is no ‘quick fix’ such as simply introducing a law specifying what is to be done coupled with the introduction of a series of additional bureaucratic procedures. The introduction of PFM/IC will take a considerable period of time to implement across a public sector, maybe 10–15 years²⁴ or more, although where there is a decentralised state each with a regional government implementation is likely to take longer. Not only within this period will the techniques associated with PFM/IC need to be implemented, including the extended financial and performance information systems, but also and fundamentally the managerial changes that will be required, including the inculcation of managerial skills. This will require the development and/or employment of skilled managers and in some countries a refocusing of elected official interests away from day-to-day administrative and operational arrangements towards the development of policy and strategy together with an oversight responsibility for operational management activity.

Indeed, introducing PFM/IC is really an ongoing reform as experience is gained and new ideas emerge. What is important in the first stage in the implementation of PFM/IC is to put in place the basic elements of this reform, that is:

• The sponsors of the reform having a clear appreciation of what the reform is essentially about with its managerial implications and promulgating widely that appreciation;

• Ensuring that a robust and skilled financial administration exists;

• That service delivery objectives, performance objectives and performance standards are established;

• Trust is built between the political level and the civil and local government service officials facilitating the delegation of operational responsibility and between central and line ministries;

• Establishing managerial structures accompanied by delegation and managerial accountability for operational management;

• Reorganising budgetary and financial accounting arrangements so that they not only provide the information and budgetary control that the ministry of finance requires but also provide the managerial information the managers require to enable them to deliver the objectives efficiently and effectively, to standard, to time and within budget;

• Developing a financial analytical and a long-term financial forecasting capability;

• Ensuring that managers, and policy makers, have the statistical data they require to accompany financial data;

• Ensuring that the objectives and activities of second-level organisations (such as agencies and state-owned enterprises) are consistent with those of the owning first-level organisation and that second-level organisations operate to the same standards as those expected of first-level organisations;

• The development of a parliamentary capacity to scrutinise managerial performance (this would go beyond that required to address the reports of the state auditor).

Only towards the end of this schedule of activity would it be appropriate to seek to introduce the bureaucratic elements associated with the reform such as the five elements of international best practice bureaucratic (i.e., COSO) requirements (see Chap. 11). What PFM/IC is NOT about is simply introducing those five elements. Yet this has been the focus of much reform activity, especially in countries joining or aiming to join the European Union and then seeing this as the starting point for the reform. These practices are important but they are only facilitators and what matters is the quality of leadership and management and how management utilises the information becoming available from those practices. In other words, these are techniques for management to utilise.

Because of the length of time that the reform will take to implement, there is a risk of ‘reform fatigue’. Therefore, a staging process should be developed where key milestones are established with progress measured against those milestones.

1.5 Applying This Reform

Applying this reform will be complex as well as requiring a long-term time horizon. Set out below is a summary of the key practical issues that need to be taken into account.

1.5.1 The Practical Consequences of the PFM/IC Reform

This section brings together issues that have been referred to earlier in this chapter. As has been shown the consequences of applying the reform extend well beyond introducing the various bureaucratic requirements because of the significant managerial implications and the impact upon budgeting and accounting arrangements. (A detailed summary of the impacts of the reform, which are very wide-ranging, is given in the annex to this chapter.) However, a key preliminary condition before countries should adopt PFM/IC is that their present public financial administration/financial control arrangements are robust. This means that fraud and corruption have limited effects; that very importantly a robust system of financial control exists and consequently that budgets are well managed. If this is not the situation, then a preliminary reform should be to ensure that the present arrangements for public financial administration are reformed to make them robust and that manipulation of the public finances does not occur through any systematic abuse of the control system. Examples of the latter have been given earlier in this chapter. Why the existence of a robust control is so essential is that a key feature of PFM/IC is the development of managerial discretion and delegation with the transfer of control responsibility from an external control by a ministry of finance to an internal control by an organisation itself. The quality of internal control then becomes primarily the responsibility of the management of each public organisation.

Another key practical, and in some countries controversial, consequence of the reform is the delegation of operational management from the political level of management to the official civil service or local government service level. For some countries this will be a significant change of approach and will require change to organisational structures. These will, in effect, be demanded by the practicalities of establishing a professionalised approach to the management of the delivery of public services. This will have major consequences for how civil and local government service officials are trained as well as how accountability arrangements evolve between the official and political levels of management. However, the reality is that not all operational management decisions need to be delegated and there will be some circumstances where delegation is inappropriate. (In Chap. 14 a discussion is included about where and where not delegation is appropriate.) A major advantage of delegation is that it creates a more informed civil (and local government) service. This is potentially to the significant advantage of the politician in the formulation of policy where cooperation between the political and operational managerial levels is highly desirable.

Because managers will require different budgetary and financial information for effective management from a ministry of finance, this will potentially expose differences between a ministry of finance budget department and line ministry managers. This could be a source of resistance and tension. The manager also requires performance information. Finance and performance need to be linked and this linkage should affect the construction of the budget as well as the type of financial analysis the manager should require. Again, this is a potential source of tension between the manager and the ministry of finance budget and financial accounting (sometimes called treasury) departments. As has been pointed out earlier, the form of analysis that suits a ministry of finance is rarely likely to meet the needs of the manager, especially where the manager is responsible for delivering objectives and performance standards efficiently and effectively as well as service quality. This involves a challenge to the traditional practices and controls exercised by a ministry of finance. It also requires the development within public organisations, other than a ministry of finance, of more sophisticated financial analytical systems (i.e., management accounting) with the development of the capacity of managers to utilise those systems. This also raises questions about the capacity of finance officers within organisations. Do they have the training to provide the information that managers require including advice about the development and strategy for the implementation of policy? They also need the analytical skills to identify those factors which impact upon efficiency and effectiveness. The question then is how are such skilled persons to be trained, recruited, used, retained and integrated into existing career structures? These are not skills that are readily available within governments and require the employment of professional, that is, more expensive, staff. Those responsible for implementing PFM/IC need to address such questions.

Also required will be performance information systems. These must be robust, relevant to the needs of the manager but subject to independent control so that the manager is not able to manipulate the information flowing from those systems and in that way demonstrate a better performance than is actually occurring.

A managerial responsibility with PFM/IC is to deliver an objective to time, to standard, within budget, efficiently and effectively. This is a far more difficult task than a simple requirement to ensure that expenditure does not exceed a prescribed budgetary limit. This demands a skill and expertise that requires development, and this in itself will mean that PFM/IC cannot be introduced without managerial change and then over a period of time as experience is gained. PFM/IC establishes a need for a high quality of managerial skill. Consequently, the reform should not be entered into without a full appreciation of what will be required in terms of managerial capability as well as the extent of the technical reforms that will be required. This therefore means thinking about how such managerial staff will be trained and/or recruited and retained. Are there, for example, to be negotiations with a university to provide appropriate managerial courses, and if there is not a capability to provide such courses, then how are they to be developed?

1.5.2 How Will the Existing Political and Operational Management React in Practice to Advanced Public Financial Management Reforms?

Where advanced public financial management reforms are to be introduced, reformers need to address how operational management is likely to respond to such reforms. This determines how effective they are likely to be. Mellett et al. (2007) have pointed out that in the example of the application of accrual accounting in the United Kingdom’s National Health Service, which has a sophisticated management, managers did not in fact utilise accrual accounting information.²⁵ Similarly, in a review of three decades of public sector reform in the United Kingdom, Christopher Hood and Ruth Dixon concluded: “As to reform making the Government Work Better and Cost Less there has been No Change.”²⁶

Again, with the introduction of another technical reform, programme budgeting, although there are different approaches (analytic and managerial), a study in 2012 by the Korea Institute of Public Finance and the World Bank pointed out that even though “experience in some … countries have shown that programs need to have clearly designated ‘owners’ with responsibility for the performance of each program. In practice, more than one ‘owner’ for a program means that resource allocation usually remains unresolved among the different owners, which defies one of the most important rationales for program budgeting. Furthermore, in such cases, it has proven extremely difficult to assess the individual performance of the ‘owners’ involved.” This study also identified that “a program inherently is a broader category of expenditure than an activity; hence, switching to a program structure inevitably enlarges the capacity of managers to decide how operating resources are used.”²⁷ The questions that this raises include is there the managerial capacity to support a programme approach and are the budgetary and accounting systems capable of adapting to the managerial requirements of a programmatic approach?

Another example illustrating the reaction to advanced financial management reforms where either strong coordination/support with local management did not occur or was inadequate or the purpose of the reforms was not fully understood has been described in a study investigating the implementation of public sector accounting reforms in Egypt, Nepal and Sri Lanka. This study described the factors that affected implementation resulting in “resistance, internal conflicts and unintended consequences, including the fabrication of results, in all three countries without any evidence of yielding better results for public sector and accountability.”²⁸

These examples emphasise the need for much greater consideration to be given by advocates of PFM reforms to the impact upon organisational cultures, management and leadership arrangements. How are managers to be encouraged to support the reform and to make use of the reform information for practical managerial purposes? From a PFM/IC perspective, unless this occurs the benefits will not materialise. For example, whilst the opportunity will emerge to improve efficiency and effectiveness it will only happen if the manager wants to do so and utilises the information that becomes available. The role of the leadership of the organisation (political and senior official) is to encourage the operational manager in this approach and to create the environment that accepts this as ‘normal and expected’ behaviour.

1.6 Individual Governments and This Reform

Each government wishing to introduce PFM/IC will need to make some adaptations to what is described in this guide in order to reflect their own administrative, legal and cultural backgrounds. However, in making any such adaptations those responsible for the reform should not move away from the principle that this reform must require a management capability to be effective. Financial management and internal control are a managerial responsibility. In other words, governments should not treat this reform as simply a reform designed to further tighten financial and budgetary controls. Though there are exceptions—some glaringly so—most countries already have tight budgetary and financial controls. These controls are often achieved in theory by systems/techniques (e.g., IT-based treasury financial accounting systems). Where weaknesses exist, the source of those weaknesses is usually a management failure in one form or another. What are also frequently lacking in countries adopting PFM/IC reform are objectives and performance standards along with those controls designed to achieve those objectives and performance standards. This is firmly a managerial responsibility, and this reform is designed to remedy that. Another deficiency is a lack of substantive measures to improve efficiency and effectiveness. Another commentator on management, Peter Drucker, defined effectiveness as ‘doing the right thing’ and efficiency as ‘doing the right thing right’: this is succinct and illuminating.²⁹ Whilst the terms efficiency and effectiveness are used frequently, in many countries they are not supported by substantive measures to identify how efficiency and effectiveness can actually be improved. The PFM/IC reform, if properly defined and applied, will address this and make such improvements possible, providing managers are prepared to take the necessary actions, that is, again a management issue.

PFM/IC adds significantly to the day-to-day responsibilities of operational managers. This is because there are several features that improve the quality of operational management. These include the setting of and accountability for the achievement of objectives and performance standards, strategic and business planning and financial analysis to achieve efficiency and effectiveness and the emphasis upon risk identification and management. These are all factors which are designed to facilitate the achievement of objectives efficiently and effectively and hence for managers to be engaged in. These features alone may require the significant organisational change as well as budgetary and accounting change referred to earlier. Not to recognise these will simply mean that the reform is just a cosmetic and is not worth the effort and cost because it will not produce the benefits that could otherwise accrue. How quickly the reform can be introduced will depend upon the administrative, cultural and legal background. Therefore, the timescales and approaches are likely to differ between countries.

Countries should also recognise that this reform is a continuing process as experience is gained and circumstances change. There is effectively no ‘end date’.

The long timescales—years if not a decade or more—will create a challenge to the ability to apply the PFM/IC reform. The officials driving the reform will change. Importantly, if the reform relies on foreign aid funding, the patience of the funder and/or availability of funds is rarely long term. A critical policy question for governments is whether they should even rely on external funding for the reform of core government systems. The term dates for such funding are generally relatively short and do not reflect the complexity and timescales for the reform of such systems including PFM/IC. In such circumstances governments should consider whether to fund this reform directly treating any aid funding as a ‘bonus’. The argument in this guide is that this reform is so important, with its managerial implications, that it is desirable in any event. A country’s financial system is at the core of its sovereignty and that makes it desirable for a government to be determined in its ownership and hence its willingness to secure the reform over time with its own funds as far as possible.

1.7 Structure of This Guide

The initial chapters of this guide provide an overview of PFM/IC. A detailed explanation is also provided of the differences between public financial management and internal control and public financial administration and internal control. Following this different chapters explain the responsibilities of the key officials who will be involved in implementing this reform. This is then followed by chapters explaining different aspects of the reform including the benefits and costs, the international standards of internal control, the impact upon the management of second-level organisations, the significance of transparency about the quality of the internal control arrangements and the relationships with public administration reform.

1.8 Summary

This chapter emphasises the nature of this reform and, in particular, that it is not just some form of financial technique but requires a management reform. What is also necessary is that there is clarity of understanding by parliament and particularly at the higher levels of government, and of their commitment to the reform. With that commitment they need to recognise what this reform is really about, namely, that the reform is principally about the more effective achievement of the government’s policy objectives and making better use of public money. This consequently affects attitudes to external accountability, not least to parliament including the information available to parliament and also to civil society.

This reform cannot be successful unless it is linked to public administration or civil service reform. Such reforms ought to change the role of political leaders as well as appointed officials with, in principle, policy execution including operational management becoming the responsibility of the civil or local government service officials and with the political level focussing on the development of policy, the strategy for the implementation of that policy and the supervision of the operational management. However, to be successful the reform must have regard to the local culture, the support of the local leadership and the present quality of the public administrative arrangements. Trying to build an advanced form of public financial management onto a weak administrative structure will not work and a first step in such circumstances has to be to improve the quality of the present administrative arrangements. Merely regarding this reform as desirable because it represents international best practice is a mistake because international best practice has no regard for the local culture and it contains assumptions that do need to be considered in its application.

Other factors affecting success with this reform are ownership, leadership of the reform process and a willingness to change established practices so that managers can have the information that they need, not least financial and performance information, and this information may be different from that required by a ministry of finance.

In undertaking this reform regard should be had to the impact on the corporate governance arrangements and that applying the reform will take a long period of time. Consequently, consistent political support will be needed.

This introductory chapter deals only briefly with many aspects of the reform. Later chapters will address individual issues in considerably more detail.

Annex 1

1.1.1 Likely Consequences of the Reform

There are many consequences of the adoption and application of the PFM/IC reform. Some are referred to in detail in Chap. 1 and others are discussed in more detail in later chapters in this guide. These consequences are summarised below.

1.1.1.1 The Managerial Consequences of the PFM/IC Reform

• A separation should exist between responsibility for policy making and strategy development (i.e., these should lie with politically appointed officials) and responsibility for policy execution including all aspects of implementation (i.e., these should lie with appointed civil and local government officials), although where the boundary is drawn will vary and depend upon circumstances and policies. (In practice in many countries this separation does not exist.) However, effective policy making does depend upon the building of cooperation between the policy maker and those responsible for implementation. Without that policy is being developed in a vacuum. Effective policy making depends upon quality analysis of information including, for example, information about what drives costs and political decisions about cost drivers (examples would be pupil/teacher ratios and penal policy) will determine the costs of providing a service.

• Objectives and performance standards should be set by the political level of management and linked with budgetary availability (frequently none of this is clearly defined).

• Operational objectives should be based upon reliable statistical analyses where appropriate (this very often does not occur).

• The head of operational management such as a state secretary (or equivalent in local government) should have a specific responsibility for the quality of operational management and the delivery of policy objectives and performance standards efficiently and effectively. In some countries no such position exists or where it does the official has relatively little authority.

• Operational management structures should exist designed by the head of operational management to deliver the objectives of the organisation (however, because objectives are not clear neither are managerial structures).

• The head of operational management should have a specific and personal responsibility to ensure that systems exist to secure effective control and utilisation of the resources of the organisation, even though a political appointee (such as a minister) may have an overall responsibility. Often the allocation of responsibilities is not clear.

• The head of operational management should ensure that assets are used efficiently and effectively and if that is not possible disposed of. In practice, assets are frequently not well managed because no such personal responsibility exists, and in effect under, or improper, use can represent a significant waste of public resources.

• The effective application of the international PFM/IC standards should be a responsibility of the head of operational management: that head should then be responsible to the political head for the quality of their application. This responsibility can only be exercised once an operational management has been established and has received management training: the international standards are not ends in themselves, they are designed to facilitate effective management and their mere legal application does not make for effective management.

• The head of operational management should ensure that new services or activities or new investments are not entered into without a full financial appraisal of the financial and investment consequences for both the current year and future years. This often does not occur because no longer run forward financial forecasting exists or effective long-term financial planning.

• The head of operational management should ensure that all risks to the achievement of the organisation’s objectives and the delivery of its services and activities are identified, evaluated and monitored. Risk management is often not well developed and at best is focused upon systems rather than also encompassing managerial objectives, not least because managerial objectives do not exist or if they do exist, they do so only in a generalised form.

• The head of operational management should ensure that no new risks are taken which would impact upon the delivery of the objectives, services and activities without a full financial appraisal of their impacts: this includes all fiscal risks and not least those that may arise from any ‘off-balance sheet’ financing arrangements such as public/private partnerships and leasing. The identification, proper authorisation and management of fiscal risks are usually not a feature of developing and transition economy financial management arrangements.

• The head of operational management should have a concern for the quality of public expenditure. This means that simply adhering to spending limits is not enough. Each ministry and other public organisation should focus on what was achieved with the allocated resources and how well resources were used, that is, how efficiently and effectively and for some activities equitably. An increased focus on outputs should improve the ability of political decision makers to prioritise objectives as well as improving the quality of the services that are being provided. (See also accountability and transparency below.)

• The head of operational management should ensure that annual financial reports are prepared in accordance with the appropriate standards: where international financial reporting standards are adopted, this is likely to require the employment of skilled and qualified accountants even though such skills are usually not readily available in the public sector.

• The head of operational management should ensure that the organisation has the prospect of long-term financial resilience taking into account the long-term impact of those external and internal factors likely to affect it such as demographic change, climate change, environmental and regulatory changes, as well as the long-term impacts of policies and new and proposed investments. Long-term financial planning is essential to secure the long-run financial resilience of an organisation, but this is rarely if ever undertaken in developing and transition economy countries and it involves much more than medium-term budgeting.

• PFM/IC requires that corporate governance arrangements are enhanced which means a greater focus upon the stakeholder interest (effectiveness) coupled with increased transparency. This is primarily a responsibility of the political head of the organisation supported though by the head of operational management. This would largely be a new aspect of public organisation management in most developing and transition economy countries.

• The head of operational management should ensure that second-level organisations, whether non-market agencies or companies controlled or owned by the first-level organisation, are managed efficiently and effectively and not used to avoid budgetary and other controls. Usually, second-level organisations are subject to very loose, if any, controls and often agencies and state-owned enterprises pursue their own agendas. This adds to the problems of effective coordination. State-owned enterprises frequently appear to be inefficient and do not meet financial targets, which are often not set anyway. All second-level bodies are a potential source of inefficient and even corrupt activity unless effectively supervised by first-level organisations.

• The head of operational management should ensure that no officials are put in any position where that official can be subject to a conflict of interests. For example, in some countries the practice is to appoint officials to be members of the boards of second-level organisations. In this example where does that employee’s loyalty lie?

1.1.1.2 The Control and Budgetary Consequences of the Reform

• The structures of control change. External control should move from a detailed control to a strategic form of control. Detailed control becomes an internal organisational responsibility, albeit so far as financial controls are concerned within parameters set by the ministry of finance. Other controls need to be developed by internal management to secure the delivery of objectives and performance standards, to time, within budget, efficiently and effectively. This would represent a radical change in control arrangements compared with traditional controls.

• Budgets should be organised in such a manner that they meet the needs of both the ministry of finance and those of the line ministry, or local government or second-level organisation management. Budgets generally do not display these characteristics with their format being wholly determined by the ministry of finance.

• Budgetary and financial controls should be adapted to respond to the needs of a managerial environment. Also, personnel controls may need to change. Such controls should have regard to the existence of a managerial environment.

• Whilst expenditure may occur only in accordance with agreed cash flow arrangements, cash flow controls may require modification to reflect the managerial environment. This also would be a major change from traditional cash flow control practice and would give to managers more influence over the timing of cash allocations.

• Expenditure planning should be undertaken in a manner which is appropriate to the needs of the organisation rather than simply the needs of the ministry of finance. Budgetary and cash flow considerations can prevent effective expenditure planning.

• The head of finance should ensure that unplanned arrears of expenditure do not arise and that managers do not incur liabilities which are to be funded from future year’s budgets except in accordance with planned and agreed arrangements. This problem arises because expenditure planning tends to be annual even where medium-term budgetary frameworks exist, and because budgetary control is focussed upon expenditure limits, inadequate consideration is given to the linkage between physical activity and expenditure flows.

• The head of operational management should ensure that all procurement is undertaken according to agreed procurement rules. Procurement rules also need to be sensitive to operational circumstances and to have regard to efficiency and effectiveness rather than simply to least cost, which is the situation in some countries.

• Policies affecting taxation, charges for services and other income-raising activities should have clear objectives including that they result in equitable charges amongst those affected by the policies and that they facilitate efficient and effective levy and collection arrangements. (Taxation policies will have more complex objectives than simply revenue raising. They will include, e.g., income redistribution, improving the operation of the economy, discouragement of imports to reduce an adverse balance of payments, promote stability in the economy, discouragement of the consumption of certain products such as tobacco and alcohol, and as a support to the promotion of government policies such as combating climate change. Taxation policies can be affected by international agreements, especially those affecting the taxation of companies.)

• The head of finance should ensure that all income due from the activities of an organisation, whether for charges, fees or other activities, is promptly invoiced and collected and that costs and losses on collection are kept to a minimum. This does not necessarily occur and pressure may exist which discourages promptness. Inadequate administrative arrangements and statistical data may also prevent the efficient and effective collection of income.

• The head of finance should ensure that operational managers have the relevant performance and accounting information to enable them to take responsibility for budgetary and financial control and for the achievement of objectives. This rarely occurs because budgets are usually simply designed to meet the needs of the ministry of finance. Also, individual managers may not know what their budgets actually are and they may have no performance information.

• Because services and activities are to be delivered efficiently and effectively, this means that operational managers need to be provided with the necessary financial analytical information linked to performance. This rarely occurs because the analysis necessary to achieve this does not exist nor the skills to undertake the analysis.

• To provide the financial and analytical information that managers will need with the application of PFM/IC, the head of operational management should ensure that a significant upgrading of the responsibilities and role of the head of finance will be required from bookkeeper/financial controller. The aim should be to ensure that this official is able to raise financial awareness throughout the organisation and to act as a financial adviser to management at all levels as well as providing the financial information and advisory support that a head of operational management would require to enable that person to properly exercise the responsibilities of the position.

1.1.1.3 The Accountability and Transparency Consequences of the Reform

• The linkage of financial inputs with envisaged outputs creates greater pressures upon managers at all levels to achieve performance, that is, the achievement of objectives and performance standards. This in turn enhances accountability at different levels. This includes providing an opportunity for parliament, perhaps through the establishment of a special committee, to assess the quality of the performance of the organisation and also at the budgetary stage enables parliament to have a specific, rather than a generalised, focus upon the objectives that are expected to be delivered for the resources to be made available. It also provides an opportunity for taxpayers, service user groups and other special interest groups (i.e., civil society) to have a clearer indication of what was expected to be achieved, not just what money was spent. Internally, it also provides the ministry of finance with better information about the quality of public expenditure.

• Transparency will be improved through the publication of reports about what has been achieved or not achieved rather than simply about expenditure compared with budgets.

• The budget is the critical document for parliamentary control and PFM/IC creates the opportunity to provide more information to parliament about objectives and performance indicators. Decisions need to be made about the extent to which such information should be provided and this should be following discussions between the ministry of finance and parliament. PFM/IC creates the opportunity for greater parliamentary scrutiny, transparency and accountability.

This is a significant list of managerial, technical and accountability consequences of the reform. However, it does illustrate that this reform is a significant reform with important impacts upon the managerial arrangements within ministries, local governments and other public organisations. As a consequence, this is a reform that is likely to take a considerable period to implement.