Stephen Peterson on Reforming Public Financial Management in Developing Countries

Developing countries face new choices and strategies in the 21st century as they seek to strengthen or reform the way their public finances are planned and managed. What is not well understood, according to Professor Stephen Peterson, is how to establish the “basics” in very poor developing countries before progressing to more sophisticated techniques.

Peterson has extensive experience in the design and implementation of successful public sector financial reform, from helping to enhance governmental transparency and accountability in Ethiopia, to teaching an interactive program designed to help government and legislative officials analyze and improve their budgetary systems. Peterson is a lecturer in public policy, faculty chair of the Executive Program in Public Financial Management, and a senior fellow at the Mossavar-Rahmani Center for Business and Government.

Q. Please elaborate on the strategies you’ve used – in Ethiopia in particular – to implement the “basics” of public financial management.

Peterson: I think the key about our strategy in Ethiopia was that it focused on sustainability at each stage. These reforms take a long time and you’re never certain when either funding or government policy will cause a hiatus in the reform.

There are really four stages to sustainable financial reform. The first stage is to get people on the same page with the existing system. What one finds, even in the developing world, is that the procedures are basically good; the issue is one of the execution of the systems.

The second stage of the reform is to improve on those existing procedures, to introduce modest changes within the existing system to increase the efficiencies. What this meant in Ethiopia was that the system was better able to be managed with fewer staff, and the staff were then released to start on the third stage which was redesign – introducing new systems in some areas. To introduce new systems you have to have staff with time and availability to be trained while other staff continue to run the existing systems.

The final stage, which is very important, is to consolidate. One can think of reform, especially in developing countries, as base camps and camps up the side of a mountain. At each one of those four stages you want to sustain the reform.

Q. What are the most common reasons reforms fail in developing countries?

Peterson: If there’s not fiscal discipline, then moving to any more sophisticated reforms is clearly not going to improve matters. But if a country does have a hard budget constraint, then they can consider the basics.

Another reason why reforms fail is that the pace and scope of the reform is simply too complex and too ambitious. These reforms can take between 10-to-15 years to complete, and it’s important that you start modestly and then leverage change at a pace that government can sustain.

It’s key for the sustainability of these reforms, and given the importance of public financial management, that the government is in the driver’s seat throughout the reform. Many reforms in developing countries are brought about by a conditionality of foreign aid. Foreign aid has a couple of problems in terms of building public financial management systems.

One problem is by making a condition that the reforms have to move at a pace that is really not feasible in terms of embedding the reform and the government fully taking it over. A second problem is that there tends to be a degree of faddism in the foreign aid community and it’s inappropriate to put in very advanced techniques in some of these countries when the basics are really what is needed.

I think, finally, these reforms do take a lot of time and do take a lot of commitment and one of the reasons you do want sustainability at each stage is that one can’t assume over a 10-to-15 year period that you will have that continuity and commitment. In Ethiopia, we had the same minister of Finance for the duration of the reform, which is quite unusual. He is the longest serving minister of finance in Africa.

Q. In light of the successes in Ethiopia, do you think that the strategies applied there can be used in other developing countries?

Peterson: I think so. I think one of the key lessons is: don’t assume what exists is not a useful starting point. In the Executive Program in Public Financial Management that we teach here at the Kennedy School, I think one of the interesting results of the course is that many of the participants who come from developing countries find that their systems really aren’t that bad, and the pathway forward is not radical change but systematic improvement. This is within their grasp, and it is appropriate in building acceptable levels of financial control.

Q. How is information technology – in as much as countries want to modernize and they want to use the tools that are available –either contributing to or complicating financial reform in developing countries?

Peterson: This topic is very current and controversial because one of the sine qua nons of improving financial management is to introduce integrated financial information systems. Unfortunately the track record of these systems in developing countries – and even developed countries – is not very positive. In some countries it has delayed reform and has been prohibitively expensive. Technology needs to be a supporter of reform, not a driver of reform. It also does not need to be on the scale, sophistication and expense that we’ve become accustomed to in the developed world. So this is an area that needs to be carefully thought through. The approach to applying these integrated systems to developing countries is very much in flux. The debate over whether to use commercial off-the-shelf systems such as Oracle financials, or custom systems, is still under debate. I think what the research shows and clearly our experience in Ethiopia shows is that a priori you cannot assume that a commercial off-the-shelf system is preferable.

Q. What are the key components of sustainability in building financial infrastructure in developing countries?

Peterson: Sustainability is critical and that’s why I think it’s important to have a strategy of evolving the government system because I think you have to bring along government staff at every step of the way. Inserting a more complicated financial system makes the government reliant, obviously, on external and perhaps inappropriate resources. The way you build sustainability, as we did in Ethiopia (we trained over 74,000 civil servants) is you have clear manuals and training materials written in the local language. You pay a lot of attention to training, training, and training. At the end of the day, you want to depend on the people, not the technology, to keep these financial systems going.

Q. Any final thoughts?

Peterson: In public financial management reform in developing countries, I think what’s important to remember is that modest improvements can have significant effects. These systems are relatively complex; they’re clearly time and mission-critical; and to approach a change in these systems with what is called a “big bang” or a massive change is really inappropriate. A modest strategy of evolutionary improvement ensures that the systems work while the reform is in place and they can evolve, eventually, to fairly sophisticated reforms. But you don’t move to sophisticated reforms overnight.

Interviewed by Molly Lanzarotta on March 17, 2008.