(Originally published 16 September 2010)
Accurate projections of the "budget baseline" are one of the most important budget preparation tools in support of fiscal discipline. The budget baseline is a projection of where aggregate expenditure is heading if government policy remains unchanged – expressed differently, of inertial trends.
I have suggested previously that the capacity to distinguish between baseline expenditure and new spending initiatives is fundamental to the effective implementation of aggregate expenditure ceilings during budget preparation: in other words, to workable top-down budgeting. If an aggregate ceiling set at the start of the budget preparation process is to be observed, it is essential to know to what extent existing expenditure policies may need to be changed in order to shift the baseline either to comply with the aggregate ceiling or to create sufficient room for essential new policy initiatives.
Budget baselines are also the cornerstone of effective medium-term budgeting. In this case, it is projections of the baseline over a 3 to 4 year period which are required. These are what are commonly known as "forward expenditure estimates".
The problem is that few countries – and exceedingly few developing countries – have the capacity to accurately project the budget baseline. Most developing countries are unable to project the budget baseline one year ahead, let alone over the medium term. This is probably the most fundamental reason why the majority of medium-term expenditure frameworks (MTEFs) are a waste of time, containing so-called medium-term expenditure forecasts which in no way capture existing expenditure policies and which are often nothing more than flat-line projections of expenditure based on the application of an inflation rate. It is striking in this context that technical assistance offered to developing countries to develop MTEFs rarely addresses the nuts and bolts of how to develop good baseline expenditure forecasts. There is, moreover, little technical literature available on the topic.
In my view, there needs to be much more focus on helping countries develop good baseline expenditure projections. And this should start with annual projections – in other words, projections of the budget baseline for the year ahead. Only when countries can prepare reasonably good annual budget baseline projections should they be encouraged to move towards medium-term budgeting.
The appropriate technique for projecting the budget baseline depends upon the circumstances and capacity of the country concerned. The baseline is a projection of where explicit or implicit commitments made by government will take aggregate expenditure, using the term "commitment" in the very broadest of senses. Some government expenditure commitments relate to inputs, the most important example being commitments to the ongoing employment of previously-hired civil servants (particularly in countries where civil servants enjoy high levels of job protection). Other government expenditure commitments are commitments to deliver certain levels of services or transfer payments to citizens – in other words, they are commitments to in respect to the outputs to be provided to the community. In more flexible, performance-oriented public management systems, the relative importance of the latter type of commitment becomes greater. Conversely, in more traditional government systems, input commitments are dominant. Taking these observations as the starting point, it is possible to sketch out the key elements of a simple budget baseline projection methodology which is not only appropriate to developing countries, but which is an excellent starting point for any country wishing to progressively develop the best possible budget baseline projections. I will outline the essence of such a simple methodology in a subsequent blog piece.