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National Fiscal Management Plan
October 10, 2003
Youngsun Koh
Korea Development Institute
Introducing the National Fiscal Management Plan
The Korean government is currently preparing
“National Fiscal Management Plan (2004-2008)”
that will be published at the end of this year.
The Plan specifies the size of aggregate expenditure
up to year 2008 in terms of the consolidated central
government and the general account. The size was
determined with a view to restraining expenditure growth
and guaranteeing long-term fiscal sustainability.
Each year, the government will prepare the budget
within the expenditure limit set out in the Plan.
Introducing the National Fiscal Management Plan
The Plan also specifies the budget allocation
in 14 areas up to year 2008.
The medium-term allocation plan reflects
the policy-priority of the present government.
Each year, line ministries will be required to submit
their budget bids within 110% of the specified allocation.
The actual allocation will be determined by the
budget authority (MPB) and approved by the parliament.
Characteristics of the previous budget process
No medium-term anchor that guides the annual budget
preparation:
- The only principle was that of “expenditure within
revenue,” which can be rephrased as
“balanced budget for every year.”
- Fiscal policy is prone to a pro-cyclical management
because an economic upturn implies a larger revenue
and a larger expenditure.
- Line ministries’ planning capacities are severely limited
because of the uncertainty surrounding the amount of
their future resources.
Characteristics of the previous budget process
Excessive reliance on a bottom-up approach in budgeting:
- Line ministries usually ask for a budget increase of
around 30%.
- MPB then enters into laborious negotiations with line
ministries, examining about 4,000 budget items.
- Examinations result in a massive cut in budget requests.
- This practice fosters incrementalism in budgeting
and makes the strategic reprioritization difficult.
- It also provides little incentive for line ministries
to economize on their spending. (Ask for money
whether or not you really need it!)
Characteristics of the previous budget process
Narrow focus on the general account:
- The budget examination is usually focused on the
general account. For example, the size, the balance, and
the allocation of the budget are usually stated in terms of
the general account.
- It is difficult to identify the impact of the total
fiscal activities of the government on the economy
and its decision-making may be distorted.
Benefits of the new expenditure framework
The new expenditure framework is expected to provide:
- A medium-term anchor for aggregate expenditure control
and sectoral allocation of budget.
- Greater flexibility in the adjustment of budget balance
to the changing economic conditions.
- Easier reprioritization of the budget and
a stronger link between policies and budget allocation.
- An incentive for line ministries to economize on their
spending and build their planning capacities.
The Need for the transition to the new framework
The financial health of the government deteriorated
markedly after the economic crisis of 1997, calling for
a medium-term fiscal consolidation strategy.
Budget balance
(% of GDP)
40
(% of GDP)
4
2
Central government liabilities
Consolidated
central government
Direct liabilities
and debt guarantees
30
0
20
-2
Direct liabilities
-4
Excluding
social security funds
-6
10
0
80 82 84 86 88 90 92 94 96 98 00 02
Source: Ministry of Finance and Economy
53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01
Source: Ministry of Finance and Economy
The Need for the transition to the new framework
More worrying is the trend growth in expenditure,
which will accelerate with the aging of the population.
Expenditure growth
(% of GDP)
50
(% of GDP)
26
Transfer
Interest payment
24
22
General government expenditure
40
30
Expenditure and
net lending
20
20
Subsidies
18
10
Investment
Expenditure
16
Consumption
0
Korea
14
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
Source: Ministry of Finance and Economy
-10
U.S
Japan
Germany France
U.K.
Canada
Others
Note: The data for Korea and Japan refer to 2000. Others refer to 2001.
Source: OECD, Economic Surveys: Korea, Volume 2003/5-March.
The Need for the transition to the new framework
At the same time, a strategic reprioritization of expenditure
is required to meet the changing demand in the society.
In particular, spending on economic affairs should be
scaled down to accommodate rising welfare expenditures.
Functional classification of spending
(% of the central government expenditure and net lending)
Education Defense Welfare Economic
(Transportation)
Affairs (Agriculture)
(Others)
’70 16.7
22.7
4.9
27.4
(11.2) (7.9) (8.3)
’80 14.6
30.6
5.7
26.0
(5.9) (6.7) (13.4)
’85 16.6
26.6
5.2
21.9
(8.3) (6.4) (7.2)
’90 17.0
20.0
8.1
20.4
(10.2) (6.1) (4.1)
’95 18.0
15.7
9.0
24.9
(11.2) (8.5) (5.2)
’00 15.3
11.4
15.3
25.2
(6.2) (9.9) (9.1)
Source: Ministry of Finance and Economy
The Need for the transition to the new framework
The net spending of special accounts and public funds has
increased substantially over the years in relation to that of
the general account, making the narrow focus on the latter
all the more inappropriate.
Expenditure and net lending by accounts
(% of GDP)
16
14
General account
12
10
8
6
Special accounts
and public funds
4
2
0
70
72
74
76
78
Source: Ministry of Finance and Economy.
80
82
84
86
88
90
92
94
96
98
00
02
The Need for the transition to the new framework
The relationship between the budget authority and
line ministries is undergoing a change.
- The scope and complexity of line ministries’ missions
has increased, making it ever more difficult for
the budget authority to control the microscopic
details of their activities.
- Too much emphasis on spending control is likely to
limit the capacity of the budget authority to analyze and
understand the policy content of the budget.
- A more macroscopic approach to budgeting is therefore
needed.
The Need for the transition to the new framework
The relationship with the parliament is also changing.
- With the democratization of the Korean politics,
the National Assembly is playing a larger role
in policy-making in general and budget-formulation
in particular.
- The larger role of the parliament can act to reduce the
centralizing power of the budget authority
in the terminology of von Hagen and Harden (1996)
and work against fiscal consolidation.
- An expenditure limit that binds the parliament as well as
the executive branch will provide a useful to control the
spending growth.
The new framework as a solution
The new expenditure framework will make it possible
for the budget authority to
- Restrain the spending growth by specifying
the expenditure limit for coming years that will be fixed
in nominal terms;
- Reprioritize the sectoral allocation of budget in a
strategic way with the medium-term allocation plan;
- Move away from the microscopic control of
line ministries’ activities and toward an in-depth review
of policies; and
- Set up binding targets for both the legislative and
the executive branches.
Macroeconomic management of the fiscal policy
The government aims to stabilize the balance excluding
social security funds and the repayment of guaranteed debts,
allowing its cyclical fluctuation around the projected trend.
Budget balance
(% of GDP)
4
Central government liabilities
(% of GDP)
40
Overall balance
Direct liabilities
and debt guarantees
2
Overall balance excluding the social security funds
and the repayment of guaranteed debts
0
30
Direct liabilities
20
-2
Overall balance excluding the social security funds
10
-4
-6
0
2003
2004
2005
2006
2007
2008
2003
2004
2005
2006
2007
2008
Budget time table under the new framework
The new framework will entail changes in the budget time
table.
- December: MPB transmits guidelines to line ministries
on how to prepare a medium-term expenditure forecasts
under the assumption of no policy change.
- January-March: Line ministries prepare expenditure
forecasts. MPB collects the forecasts, examines
new spending needs, and prepares a plan for the
sectoral allocation of budget for the next fiscal year.
Budget time table under the new framework
- March: The cabinet decides on the size of total
expenditure and its sectoral allocation, and submits the
National Fiscal Management Plan to the parliament,
which is subsequently approved. MBP transmits the
budget preparation guideline to line ministries.
- April-May: Line ministries prepare budget bids.
- June-August: MPB negotiates budget bids with
line ministries and prepares the draft budget.
- September-October: The draft budget is approved
by the cabinet and submitted to the parliament.
- December: The parliament approves the budget.
Budget time table under the new framework
The new budget time table implies that
- The budget preparation work by MPB will be spread out
over the year rather than being bunched up around
June-August as is the case now; and
- Line ministries will be informed of the total amount of
available resources at the early stage of budget
preparation, and their work will be accordingly
carried out in a more orderly fashion.