Zero-based and cash budgeting should both be adopted by government

Finance minister Tito Mboweni has made remarks that seem to favour zero-based budgeting, an approach that would weigh each expenditure item, each departmental budget, against government goals. The Minister has said that this would entail focusing on 'infrastructure development and other growth-enhancing measures' and come at the expense of those programmes considered wasteful in relative terms.

Of course, the devil is in the details. This plan could either lead to gains in the efficiency of government spending, or to even more waste as government spending exacerbates our unfortunate economic circumstances. The government has to measure the right things, in the right way. It is not enough to rely on models making untested assumptions.

The implications of this is that the nature of fiscal policy itself has to change. If the government simply views the fiscus as a tool for influencing macroeconomic aggregates, the assumptions needed to reach this 'conclusion' are likely to lead to significant errors and unintended consequences. This would undermine the zero-based budgeting approach itself. 

A certain measure of humility is required as to the government’s ability to make efficient investments. The history of our State-owned enterprises shows this clearly.

The government can be most effective in removing the barriers, created by government policy itself, to the formation and growth of small business. These include the unintended consequences of past government interventions, such as the National Minimum Wage, which has led to increases in the salaries of some people at the expense of many more who have lost their jobs or are now unable to find jobs, the latter being something the government or anyone else cannot measure accurately.

Markets are complex and are the emergent phenomenon that arises from people simply working to meet their needs and wants through voluntary transactions.

Humility in the face of such complexity is warranted. This is why successful businesses are continuously changing to try and meet market demands. Many of these businesses fail, and this is consumer choice as much as it is of which businesses survive and thrive. Any interference by the government can only disturb consumers from meeting their wants and needs efficiently, in a similar manner to how past government interference has led to high data prices, high import costs, high labour costs, etc.

This means that some humility about what can be achieved through government spending needs to take root, regardless of what budgeting process is in place. Having said that, there's also a method of budgeting that recognises the importance of efficient government spending and has real, enforceable consequences built in: Cash budgeting. Cash budgeting was tried during Zimbabwe's Government of National Unity with impressive results.

This method of budgeting entails expenditure never exceeding expected/estimated revenue. This means you only spend as much as the cash you expect to receive in income / revenue. It is a commitment to conducting fiscal affairs on the basis of a surplus or neutral budget balance. Tendai Biti, former Zimbabwean finance minister, described it as "we eat what we kill" or "what we gather is what we eat" in his 2014 paper for the Center for Global Development (CGD).

Zero-based budgeting critically depends on the methodology chosen, which can lead to more, or less, inefficiency. With cash budgeting, there’s a feedback loop between government spending decisions, their effect on the economy, and consequently, government revenue. This means that when government spending is inefficient, GDP or national income is reduced, and tax revenue is also reduced. This in turn means the government has less money available to spend when it makes bad economic decisions.

Conversely, the government is rewarded for making the right decisions through an increase in revenue and therefore the budget can also increase. This approach has the advantage that it includes real and proper incentives that are independent of the willingness of the government to enforce them. It means that as long as cash budgeting is the budgeting method, governments will be operating under a strong incentive to make their spending efficient with regards to its impact on the economy.

It is important to remember that the suggestion by the Minister is driven by a real problem faced by the Treasury. This includes the 2020 main budget reduction in baseline expenditure over the next three years of R261 billion. Accounting for additions and re-allocations, this comes out at a net reduction of R156.1 billion, keeping in mind that R60.1 billion of new expenditure was budgeted for Eskom and SAA.

The reductions in baselines cannot be assumed under a zero-based budgeting approach if the methodology chosen to compare different areas of expenditure for effectiveness is itself flawed. The amount of political pressure public servants are able to bring to bear, for example, will be a key determinant of whether the budgeted reduction of the wage bill as part of the baseline reductions can be achieved. This is before the impact of the COVID-19 lockdown is considered.

Zero-based budgeting can lead to a situation where government spending is optimised. This is by no means guaranteed in the public sector with its susceptibility to non-market, political pressures. On the other hand, cash budgeting provides a means by which a constant feedback loop between government spending and the economic prosperity of its people is established.

This article was first published on BusinessBrief on 25 June 2020

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