I.COMPARATIVE LAW, CONSTITUTIONS, POLITICS AND BUDGET SYSTEMS

difference between Denmark and Norway is the issuing authority for the regulations: the Ministry of Finance as opposed to Parliament. In both cases, Parliament is fully involved in any changes in the regulations. But unlike nearly all OECD countries, formal law for governing budget processes is absent.

Only a few OECD countries do not have a constitution contained in a single document, for example Canada, New Zealand and the United Kingdom. These countries also have several statutes pertaining to the budget system, which have evolved on a piecemeal basis over a long number of years. Beginning in the 1980s, New Zealand strengthened its legal framework for budget processes, including adopting a new law that specifies the responsibility of the government to report to Parliament and the individual responsibilities of the key budget players (including those of chief executives in core government departments, who deliver outputs consistent with the government’s budgetary objectives). In these Westminster countries, parliamentary regulations (“Standing Orders”) and/ or parliamentary resolutions contain provisions which, in countries with strong legal traditions, would be incorporated in formal law. The ministries of finance (sometimes known as “the Treasury”) in Westminster countries have strong inherited budget-related powers, several of which are given force by treasury regulations.

3. Can economic theory explain the differences?

This subsection reviews various branches of public finance literature with a view to examining the extent to which different schools of thought provide explanations as to why the laws underlying budget systems differ so widely across countries. This literature review provides some insights into the nature of fiscal “rules” (“institutions” in the literature), especially those which have an impact on budgetary outcomes. However, they do not provide a comprehensive view as to why various budgetary rules have been embodied (or not) in the different types of laws of OECD countries.

3.1. New institutional economics

New institutional economics has defined rules very broadly. One Nobel Prize laureate defines an “institution” as any socially imposed constraint upon human behaviour (North, 1991a, Chapter 1). “Institutions” provide the broad framework of formal and informal rules and constraints that govern the way organisations, as groups of people, function. Formal rules include constitutions and laws. Informal constraints include customs, codes of conduct and sanctions (North, 1991b).

In this literature, “institutions” are distinguished from “organisations”. Constitutions, for example, are regarded as institutions, whereas legislatures

I.COMPARATIVE LAW, CONSTITUTIONS, POLITICS AND BUDGET SYSTEMS

and executives are organisations that operate under the constitution. The interaction between institutions and organisations affects the cost of transactions. Appropriate rules can minimise various transaction costs associated with incomplete contracting or asymmetrical information (Williamson, 1996). The insights from new institutional economics are applicable mainly to private sector markets and firms. However, the New Zealand government applied this theory to the public sector, notably its emphasis on the need to minimise transactions costs associated with information asymmetries and agency problems (Scott et al., 1997, p. 360). New contractual relationships, supported by law, have been pursued with vigour in New Zealand (Schick, 1996).

One could model the “institutions” as the set of formal and informal budget rules contained in constitutions, budget system laws and associated regulations. The “organisations” are the executives, legislatures, and independent external audit organisations – the three main players of generic budget processes. “Contracts” govern the roles and powers of various executive branch organisations (e.g. cabinets, ministries of finance, spending ministries and agencies) and legislatures (e.g. plenary sessions, specialised budget committees of each house of Parliament). The insights of new institutional economics do not appear to have been systematically used for such modelling, in which the role of budget system law is also important. Also, the literature has not analysed why budgetary “institutions” have evolved incrementally over long time periods.

Nonetheless, some recent reforms of budget system laws have aimed at addressing transaction costs, particularly information asymmetries. There has been an emphasis on enhancing transparency and providing more budgetary information to Parliament and the public, as well as strengthening Parliament’s “contract” with the executive to be accountable in its preparation and execution of the annual budget approved by the legislature. For example, a budget system law may specify the “contractual terms” for the executive’s rights to alter the approved budget during the implementation phase.

3.2. Law, economics and public choice theory

Studies of the interface between law and economics could potentially provide guidance as to why budget system laws differ widely, especially given that the literature emphasises efficiency (Van der Hauwe, 1999, p. 610) – one criterion for assessing budgetary systems. In general, the major focus of the law and economics literature is on the interaction between private sector economic behaviour and law (Werin, 2003). In Anglo-Saxon countries, lawyers recognise that they were slow to appreciate the impact on legal systems of the changing role of “the contracting state” (Taggart, 1997).

I.COMPARATIVE LAW, CONSTITUTIONS, POLITICS AND BUDGET SYSTEMS

In contrast, in continental European countries, law and public finance studies have long been intertwined. Law is generally given primacy over economics – advanced public finance studies are taught in law (not economics) faculties. Within national administrations, large numbers of people with legal training are employed in finance ministries. In Germany, employment and salary incentives in the Federal Ministry of Finance are more favourable for lawyers than for economists (Würzel, 2003, footnote 8). In contrast, theoretical economists in English-speaking countries are reluctant to adopt a legal perspective for budget systems. Brennan and Buchanan (1985) argue that there is constitutional illiteracy amongst economists, who are poorly equipped to assess the rules needed for power struggles. With regard to budget systems, such struggles take place between executives and Parliaments.

Public choice theory and its several “schools” have developed within the economics and law discipline (for a review, see Medema and Mercuro, 1997). The role of the public choice theorist is “to advise citizens on the working of alternative constitutional rules” (Brennan and Buchanan, 1988). One tenet of public choice theory is that legislators and government officials do not act for the common good (McAuslan, 1988). Rules, including changes in actual constitutions, are seen as necessary to tame self-seeking politicians’ exploitative ways.

Public choice theorists generally do not examine budget processes comprehensively – at best only particular “rules” are advocated. For example, some public choice theorists (e.g. Buchanan, 1997) have proposed that a “balanced budget” rule is so fundamental that it should be inserted into the constitution (this argument has been largely confined to the United States). Under this view, ordinary law or informal agreements are not seen to provide the necessary permanency needed for the conduct of prudent fiscal policy.

3.3. Constitutional political economy: budgetary rules and budgetary outcomes

Constitutional political economy focuses particularly on the analysis of the choice of rules. As a separate discipline (Voigt, 2003), the literature is usually at a general level (e.g. Weingast, 1996). One branch of constitutional political economy focuses on the impact that alternative rules have on economic outcomes.

As from the early 1990s, the role of “institutions” (rules) and budgetary performance has been examined extensively. An index of various budgetary rules was first constructed for European Union countries and it was found to be correlated with budget performance (von Hagen, 1992). These studies were refined (von Hagen and Harden, 1994) and provided with a theoretical basis (von Hagen and Harden, 1995). The literature had a considerable influence on the development of formal “fiscal rules” on government deficits and debt,

I.COMPARATIVE LAW, CONSTITUTIONS, POLITICS AND BUDGET SYSTEMS

notably the Maastricht criteria for EU countries. Empirical studies associated with this literature have burgeoned, covering Latin America (Alesina et al., 1996), Eastern Europe (Gleich, 2003; Yläoutinen, 2004), Australia, New Zealand, selected Asian and African countries (Campos and Pradhan, 1996). Studies in this area, including for Switzerland, are reviewed by Kirchgässner (2001).

In a related strain of research, Persson and Tabellini (2001) have examined the effect of electoral rules and political regimes on fiscal policy outcomes. Relative to parliamentary regimes, presidential regimes are associated with smaller governments, as are majoritarian elections relative to systems of proportional representation. The role of budget system law is not examined in this literature. However, it does hypothesise that rules are needed to mitigate conflict over budget disputes within the executive, within the legislature and between the two branches, in order to reduce deficits and government debt. These studies provide a framework for considering which budget processes are important for fiscal stability. However, they do not provide guidance as to which elements of budget processes should be included in formal law and those which should be left informal and non-legally binding (e.g. the dominant role of the Minister of Finance in Cabinet).

Views may differ as to whether Parliament should dictate particular rules by adopting primary law(s) or whether the executive should drive budget processes using regulations (executive-controlled “rules”). An executive’s decision to issue secondary laws (or not to do so) – from the powers that are delegated to it by primary law or inherited by it from former times – is generally not examined in this literature. Also, the important role of external audit in identifying budgetary mismanagement and suggesting changes in “institutions” is absent from this literature. In contrast, this study and INTOSAI4 consider that a rules-based external audit organisation is essential for improving budgetary performance.

3.4. Can game theory help?

In game theory, political strategies, social choice and economic outcomes are integrally linked. Strategic actors have the capacity to make binding commitments, with an exogenous enforcement institution that guarantees the promised outcome (Shepsle, 1998). Although this approach has been applied to collective decision making as well as to law (Baird et al., 1994), it has not been systematically applied to budget system law. Game theory has been used to model the supply of public services, provided by the bureaucracy, to meet the demand for public services. Kraan (1996) develops a model for the interactions between politicians and bureaucrats, as opposed to the rules needed for budget processes. The study concludes that the bargaining skills of the actors are the primary determinants of budgetary outcomes.