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THE ECONOMIC AND SOCIAL REVIEW
V INSTITUTIONAL REFORM
Fiscal institutions have important consequences for the spending
performance of governments, both in terms of the level of spending, the
composition of spending, and the levels of deficits and debts. This suggests
that appropriate institutional design can help mitigate problems of waste,
divergences between public preferences and what the public sector delivers,
and fiscal profligacy.
This claim rests on the basic conjecture that institutions frame the
decisions made within them, i.e., that a given group of individuals facing a
given problem makes predictably different decisions under different
institutional arrangements. The obvious objection is, that policy makers would
rid themselves of the institutions and ignore or change the rules if they feel
constrained by them. After all, institutions are man-made and subject to
change. Without a satisfactory answer to this objection, the power of
institutions and the promises of institutional reform must remain in doubt.
Such an answer has three points. First, the individuals involved in
decisions over public finances do not always have the authority themselves to
change the rules. Second, even if policy makers feel constrained by existing
institutions, they will want to change these institutions, only if they can be
reasonably sure to achieve more desirable outcomes under the alternative. But
this is far from trivial. Complex decisions made by groups are prone to
instability and irrationality. Therefore, the absence of institutional rules is
often much less desirable than the presence of rules, even if their constraints
are being felt. Third, institutional rules in the budget context give individual
policy makers assurance that excessive budget demands by others will not be
successful, and thus make it easier for them to restrain their own demands.
Nevertheless, one should not interpret the theory and evidence outlined
above as saying that a change in the letter of the law is an effective means to
reduce rents, excessive spending, and deficits. Precisely because changing
institutions takes some extraordinary effort, policy makers are unlikely to do
that unless they are aware of an acute fiscal problem. But if that is the case,
how can we prove that the institutional change contributed to the fiscal
correction, if the latter was what policy makers wanted anyway?
A first point is that institutional changes are very visible to the public and
the markets and, therefore provide an important signalling function.
Governments showing the resolve for a more disciplined fiscal policy by
reforming pertinent institutions will find it easier to convince the public and
financial markets of their good intentions. To the extent that this reduces
opposition against fiscal reforms and cutbacks, the necessary policy changes
are made easier.