Managing money in the Pacific

Size matters when it comes to public financial management in Pacific island countries

Tobias Haque, David Knight, Dinuk Jayasuriya

Development, Economics and finance, Government and governance | The Pacific

6 October 2015

Governments and donors should consider the available skills in the public service in Pacific island countries when designing public financial management reforms, write Tobias Haque, David Knight and Dinuk Jayasuriya.

Much attention is currently being paid to public financial management in Pacific island countries. Improving systems for raising tax revenues, allocating resources between ministries and sectors, and achieving value for money through public expenditure is a stated priority of governments and donors across the region. Most Pacific Island governments now have some kind of public financial management (PFM) reform process in place to achieve such improvements, and these reform processes are generally enthusiastically supported by donors, who increasingly make use of country financial management systems in delivering aid.

But PFM reform is an arcane field, in which there is surprisingly little agreement as to appropriate models and relative priorities for reform efforts.  While Pacific island countries are often considered to have “weak” PFM systems, there is little analysis of how these countries’ PFM systems differ from those in other developing countries. Few explanations for weakness in Pacific island countries’ PFM systems have been presented beyond the usual vague appeals to “culture” or “governance”.

In our recently published research, we used PEFA assessment scores (a standardised international scorecard for measuring the quality of various aspects of PFM systems) to empirically examine patterns in the PFM performance of Pacific island countries, and examined the performance of these countries relative to other countries of similar income, to identify causes for the apparent weaker performance of those in the Pacific.

Income and population size exert a significant influence on PFM performance of all countries. Smaller countries face a significant size penalty in PEFA scores. Taking account of differences in income, small countries have weaker PFM systems. Overall, the weaker performance of Pacific island countries can be entirely explained by their smaller population sizes and levels of income.

Population impacts on PFM performance of small countries through the imposition of capacity constraints. The weaker PFM performance of smaller countries is driven by problems undertaking PFM functions that require specialised skills (including, for example, audit and procurement). Small countries, with smaller public services (in absolute terms) find it harder to recruit and retain people with appropriate specialised skills. These capacity constraints are avoided by countries that have populations adequate to provide a critical mass of required skills and resources to the public sector. The lag in performance from capacity constraints associated with smallness seem to outweigh any potential benefits of smallness, such as a smaller number of administrative units, less spending through sub-national governments, or easier communication.

Population size exerts the most significant constraint on PFM functions that are technically specialised and need to be carried out beyond central agencies (such as procurement and financial reporting). Available technical capacity in small countries is often concentrated within central agencies, which also typically benefit from external technical assistance to PFM processes and reforms. PFM functions that can be undertaken within these ministries are therefore performed better than technically-demanding functions that must be carried out at the level of line agencies. Smaller countries therefore lag furthest in technically-demanding functions that are required outside of central agencies.

The primary lesson from this is that the scope and ambition of PFM reform programs needs to be appropriately calibrated to the context of small Pacific island countries. These countries face fundamental disadvantages to implementing standard PFM systems because of inherent skill gaps. It is therefore unrealistic to expect the successful implementation of PFM systems employed in much larger countries at similar levels of income.

Image by DFAT on Flickr. https://www.flickr.com/photos/dfataustralianaid/10702579034

Image by DFAT on Flickr. https://www.flickr.com/photos/dfataustralianaid/10702579034

So what does all this mean for governments and donors involved in PFM reforms?

Firstly, they need to ensure that scarce capacity is targeted to areas with highest return. If a country has, and is likely to continue to have, only a small pool of qualified accountants, lawyers, IT specialists, or individuals experienced in financial planning, then it is important that these individuals are used in areas where they can have the greatest impact, and sufficiently concentrated in these areas to achieve results. PFM reform efforts should therefore be targeted towards weaknesses in PFM systems that are exerting the greatest constraint on the achievement of broader development objectives.

Secondly, governments and donors should examine the balance in external assistance between central and line agencies. Donors tend to focus technical assistance support to PFM reform within central agencies. But the capacity constraints faced by small Pacific island countries have the greatest impact at the level of line agencies. The areas in which small Pacific island countries perform particularly weakly are unlikely to be well addressed by technical assistance or PFM reform programs centered on Ministries of Finance. Particular emphasis on technical assistance and capacity building in line agencies may therefore be required in these countries.

Finally, they need to recognise the likely ongoing nature of capacity constraints and need for capacity supplementation. Small Pacific island countries lag other countries in PFM areas that require specialist capacities. These capacities are not easily built or retained. Options may need to be considered for accessing international capacity on a continuing basis, if capacity constraints to achieving a priority policy objective in public financial management are unlikely to be surmountable with local resources alone. While some capacities can undoubtedly be developed locally, others are likely to need to be ‘imported’ on a continuous basis over the long term.

Overall, the small absolute size of Pacific island country public sectors is an important contextual factor that should be taken into account when designing public financial management reforms. With limited capacity, it is important that such reforms are carefully prioritised towards addressing binding constraints to service delivery or macroeconomic performance. Development partners should consider the balance between technical assistance support to central and line agencies, and the full range of options available to fill capacity gaps, including continuous provision of technical assistance.

This piece is based on an article by the authors in Asia & the Pacific Policy Studies, ‘Capacity constraints and public financial management in small Pacific Island countries‘.

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