Budget optimization. Some suggestions

A simple analysis of the State Budget for 2014 allows to find opportunities for savings of up to 3% of GDP

Lynda.com

Authors:

Dmytro Boyarchuk, Vladimir Fedorin, Serhiy Marchenko and Ilona Sologoub

Socrates, a Contemporary of the Future, and A Man from the Beginning of the Alphabet, Kakha Bendukidze, was a hard core proponent of the the ruthless budget (waste) cutting. One of the latest articles he co-authored reflects Kakha` understanding of priority action-steps for Ukraine, and succinctly summarizes relevant suggestions on expenditures reduction. In a nutshell [1], Ukraine should cut public expenditures by no less than 10% of GDP, as current budgetary position is becoming a threat to the national security. 

Candidates for cutting:

  • Energy subsisdies (that are expected to amount nearly 10% of GDP in 2014)
  • Old Nomenclatura ( with extraordinary high public pensions amounting more than 18% of GDP with nearly 4%going to special pensions)
  • Public procurement
  • Redundant regulation and bureaucracy
  • Expenditure items comprising inefficient subsidies intended to help low-income, but don`t serve this purpose in reality

This line of thinking is extended in the following article based on budget review conducted by a VoxUkraine team comprised of Dmytro Boyarchuk, Vladimir Fedorin, Serhiy Marchenko and Ilona Sologoub. This piece has a remarkable meaning, as the idea to initiate the project was born during the conversation with Kakha, and because it illuminates the contrast between purposeful tactics and “actions barely connected to the common good”.

A simple analysis of the State Budget for 2014 allows to find opportunities for savings of up to 3% of GDP. Proposed structural reforms will lead to even more efficient use of the budget funds over the 1-3 year horizon.

Currently Ukraine has rather big government as compared to other countries:

diagram

Diagram 1 shows that in Ukraine the share of GDP redistributed by central government is comparable to “old” EU countries, and is much higher than in post-Soviet or neighbouring countries, to which Ukraine is usually compared.

Today, when budget revenues are falling, and possibilities for borrowing are scarce, this level of spending becomes unsustainable – so there is no alternative to budget cuts. Our calculations show that it is possible to reduce budget expenses by about 3% of GDP since 2015 by elimination of the obvious waste (a detailed file with calculations can be downloaded here). Freezing the rest of budget expenditures in the nominal terms would reduce Central budget expenditures from current 29% of GDP to 23% of GDP (using IMF forecast of GDP).

The main items for economy: reduction of expenditures on the staff of central government bodies on average by 25%, liquidation of ministerial “R&D” units because they do not produce any tangible results, restructuring of the Academies of Sciences (as a result of reform, research should be financed on the project basis), freezing of the state support of the coal mines on the occupied territory. The results of calculations are presented in the following table:

Central budget UAH billion % GDP
Immediate reduction of expenses 41.9 2.75
Articles that need audit and review 12.6 0.83
Expenditures that will be fully or partially reduced in the course of reforms (1-3 years) 128 8.41

Source: IMF GDP forecast for 2014, State Budget Law-2014, own calculations

Further reduction of budget expenses  would be possible within the next 1-3 years under the condition of implementation of structural reforms proposed below.

1. Optimization of public procurement procedures. There are two components of this – (1) reduction of the size of the government and introduction of new technologies (e.g. a government body that employs less people and uses electronic document flow, will need less paper, pens and printer cartridges), and (2) reduction of “kickbacks”. The first component will be implemented during general government reform described below, the second one needs raising transparency of the government, namely, a prompt on-line publication of all the documents related to public procurement (this should be prescribed by law). To further raise transparency, each government body should publish its very detailed budget for the year, so that their needs became clear before tenders are announced. For example, if some ministry intends to purchase a few iPhones for its staff, the public should see it in its budget published at the beginning of the year rather than in the “Visnyk Derzhzakupivel”.

2. Optimization of the state enterprises network. Today, each ministry owns several (sometimes dozens) of enterprises that work in a non-transparent way, consume state resources and often distort respective markets. Among the most notorious examples is the state company “Ukrekoresursy” that is directly subordinate to the government and without a contract with which no packed goods can be imported to Ukraine. These enterprises should be audited, and afterwards either liquidated or privatized. This measure would allow to kill several birds with one stone – to reduce government expenditures and quasi-fiscal pressure on business, to receive privatization revenues, and to liquidate hotbeds of corruption.

3. Reform of state monopolies – Naftogas, Ukrzalianytsia, Ukravtodor and the like, which are extremely non-transparent and allegedly loss-making. First, audit them, then split and sell whatever possible. Naftogas reform is an essential part of the energy reform, which also implies elimination of cross-subsidization and closing of unprofitable mines. This article provides very strong arguments for the Naftogas reform. In fact, if this stone remains on the neck of Ukraine, our country will sink.

4. Transfer to means-tested social benefits system. Ukrainian privilege-based social protection system favors mostly people who can pay for themselves. Thus, only a third of expenses aimed at social protection reach the poorest 20% population. Means-tested system will target those really in need, and at the same time save budget funds. All the privileges to social groups should be cancelled.

5. Healthcare reform. Transfer to insurance-based healthcare, perhaps with some free emergency services.

6. Agricultural reform. If a working land market is introduced, this would allow to considerably reduce subsidies to agribusiness because the land will be reallocated to more efficient owners.

7. Governance reform (deregulation and raising of state management efficiency). This is not a very fast thing if done properly but it will result in considerable savings. As an immediate measure, the expenses on the state management can be reduced by 25% since January 1st, 2015. This reduction is justified because for no obvious reason the number of state officials increased from 275 thousand in 2012 to 335 thousand in 2013, or by more than 22%. Recent change in the composition of government bodies is a step in the right direction, but it is only a start.

We propose function-based approach to the composition of the government mechanism. This approach is described in the following table – this is just a sketch, and we invite everyone to participate in the discussion.

Function of the state (public good) Responsible government body
Protection of life, freedom and property of individuals For internal threats: police and prosecution. We propose to create local [elected] sheriff’s offices to deal with “light” violations, and a state-level investigation service for heavy crimesFor external threats: army/defense, Security service (SBU). We propose to deprive SBU of all functions not connected to counteracting terrorism and Russian aggression
Law enforcement and dispute settlement Judicial system
Registration of citizens and their property (property rights protection) Ministry of Justice
Protection of health of citizensProphylactics: setting safety standards for products and drugs, checking compliance with these standardsProphylactics: advertising healthy lifestyle, creation of opportunities for mass sportsHealthcare: unconditional and universal assistance in emergency cases; a wise mix of insurance and state-paid healthcare for other cases An analog of Food and Drug Administration (but smaller than our Sanitary and Veterinary service)Ministry of Social PolicyMinistry of Social Policy
Protection of the poorest and integration of special needs people, including refugees Ministry of Social Policy. Means-tested basis
Relations with other countries Ministry of External Relations. It should also include external trade relations, for example, trade representatives at Ukrainian embassies abroad
Managing public finance Ministry of financeFiscal service (taxes and duties collection)
Management of state-owned assets Respective ministries (defense, education etc.)General principle – private management is more efficient than state management, so whatever can be sold without threatening national security, should be sold (organization of the privatization process can be outsourced to a private partner)
Encouraging competition and correcting market failures when needed Anti-monopoly Committee. Should be very transparent. Should also be allowed to cap tariffs of natural monopolies
Education Pre-school, secondary, out-of-school – responsibility of the local governmentGeneral regulation – the Ministry of education. The sphere should be deregulated as much as possible to increase competition between educational institutions to improve the quality of education. Educational institutions preparing specialists for certain industries (agriculture, fishing) should be either privatized or supported by those industries, not the state.
Support of “hard” science and fundamental research Project-based financing model.Since 2015, financing of all the Academies of Sciences (of Pedagogical Sciences, of Legal Sciences, of Agrarian Sciences etc.) should be considerably reduced. In the long run, these should not be supported by the state at all.
Infrastructure development Ministry of infrastructure
Support of cultural projects Project-based support. After it is introduced, the Ministry of Culture will not be needed.
Management of natural resources Ministry of Ecology

Based on the above table, the tentative list of government bodies that can be liquidated looks like this:

  1. Ministry of Economic Development (international trade transferred to the Ministry of External Affairs, macroeconomic forecasting – to the Ministry of Finance or the National Bank)
  2. Ministry of Regional Development
  3. Ministry of Agrarian Policy
  4. Ministry of Health (merge with the Ministry of Social policy)
  5. Ministry of Youth and Sports (merge with the Ministry of Social policy)
  6. State Agency of energy efficiency and energy savings (market mechanisms should encourage these)
  7. State Agency of cinema
  8. State Agency of science and innovation
  9. State Agency of medicine and drugs (merge with food and other products safety agency)
  10. State Agency of fishery
  11. State Service of labour safety (when judicial system is functioning properly, worker insurance should solve this issue)
  12. National Agency for Government Service Issues
  13. State space agency
  14. State Agency of regulatory policy (merge with АМС)
  15. National Commission for regulation of energy and communal services (these are АМС functions)
  16. State Agency of Chernobyl zone management (include into the Emergency Service or the Ministry of Infrastructure)
  17. National Commission for protection of population from radiation (same arguments as with above agency)
  18. National service for intermediation (a functioning judicial system makes this redundant)
  19. State architecture and construction inspection (this should be regulated by market and the working mechanism of public discussions)
  20. State property Fund

Liquidation of the Ministry of Culture and Ministry of Energy should be discussed.

We admit that the governance reform, as any other reform, will require some investment before it starts bearing fruit. The most obvious source of funds for this investment is privatization.

Note: we did not consider local budgets, budgets of the Pension Fund and other Social Security funds, as well as budgets of state monopolies, such as Naftogas, Ukravtodor, Ukrzaliznytsia, so we did not spot all the inefficiencies in the government spending.

Thus, the decentralization reform would reduce subventions to local budgets considerably. Although the central budget revenues would also be reduced, we suppose that this reform would lead to more efficient usage of local budget funds.

Budgets of the state monopolies are simply not available, but possibilities for economizing (as well as for rent-seeking) in these enterprises are enormous.

The article also appears in Ліга.Бизнес

Notes

[1] Acemoglu, Daron, Anders Aslund, Kakha Bendukidze, Oleh Havrylyshyn, and Basil Kalymon. Recommendations for immediate policy actions to address financial crisis in Ukraine. KyivPost.Oct.2014 (link)


Disclaimer

The authors do not work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations