After the Financial Crisis, a Challenging Mandate for Ministries of Finance
The global financial crisis has ushered in a new era for ministries of finance worldwide. These bodies now must do more, and solve more complex problems, than at any time in recent economic history. A Booz & Company survey of more than 60 finance ministers and senior staff at those ministries, along with other economic thought leaders, has revealed a new agenda that if implemented properly would lead to efficient and effective economic cycles.
The worst effects of the global financial crisis have been contained. However, the range of extraordinary steps required to accomplish that feat—from stimulus spending to asset purchases and guarantees—have transformed the mandate for ministries of finance, leaving these entities with responsibility for far more elements of economic management than they had in the past.
Booz & Company solicited input via a survey of more than 60 decision makers, with influential roles in national economies worldwide, along with internationally recognized thought leaders in macroeconomic and fiscal policy, as part of a global campaign to investigate the evolving roles and responsibilities of finance ministries. The survey results indicate what fiscal and economic measures are currently being implemented in these economies, and underscore the urgency of reforms.
Many countries have taken steps to reform their economic and fiscal management.“ Although laudable, these measures have been met with increasing political resistance—as well as varying degrees of success—since they represent isolated steps taken by finance ministries that continue to operate with the same institutional and operational setup they employed before the crisis,” says Dr. Jihad Azour, Senior Executive Advisor, Booz & Company. Instead, finance ministries need to make fundamental shifts in their operational and institutional models across four key mandate areas:
Public finance management. Large fiscal deficits caused by the crisis and its aftermath require stronger management of government finances.
Asset and liability management. The massive acquisitions required to stabilize economies, along with the severe amounts of debt incurred in the process, have compounded the challenge of managing current and long-term state-owned assets and liabilities.
Economic management. The crisis blurred the lines between macroeconomic players, leading to questions regarding the role of finance ministries in overseeing their national economies during normal and extreme business cycles.
Accountability and transparency. Ensuring accountability and transparency strictly for compliance purposes is no longer sufficient. Instead, finance ministries must now ensure accountability and transparency to increase the credibility of the country’s macroeconomic management as a whole.
If finance ministries are to successfully lead the way in economic management in the post-crisis era, they must prioritize the challenges they now face across all four mandate areas so that those challenges can be addressed comprehensively, instead of through isolated, ad hoc policy changes.
Although the four mandate areas are universal, the specific reform approach will vary from country to country. “With different debt levels, fiscal imbalances, and growth prospects across countries, there is no one-size-fits-all solution,” says Peter Burns, Partner, Booz & Company. “However, by analyzing countries as members of a cluster with similar economic features and challenges, finance ministries within each cluster can establish reform priorities.”
Seven Clusters with a Range of Priorities
Booz & Company grouped a large cross-section of countries into clusters according to several factors: government fiscal balance and gross government debt; the size of government intervention in the economy during the crisis; and the amount of leeway those governments have to implement fiscal and economic policy changes. The result is seven clusters with comparable economic characteristics and broadly similar reform priorities.
1. Countries with Little Room to Maneuver: Examples include Austria, Belgium, Greece, Ireland, Italy, Netherlands, Portugal, and Spain.
Advanced economies in this first group are facing high deficits, high government debt, a record of strong intervention during the financial crisis, and relatively low flexibility regarding fiscal and monetary measures currently at hand. Finance ministries in this group must first redefine social safety nets such as pensions and healthcare systems. Second, they must rethink the parameters of government activity, based on the assumption that private enterprise can execute certain services and functions more efficiently than government can.. Finally, they must raise their debt-management profile, by developing capabilities that allow them to treat government debt more like corporate debt.
2. Heavyweight Countries with Heavyweight Problems: Examples include France, Germany, Japan, the U.K., and the U.S.
This group includes advanced economies with high debt loads and structural deficits, relatively high levels of fiscal stimulus during the crisis, and a degree of flexibility for further fiscal and monetary interventions. Countries in this group share the reform priorities of the first cluster. In addition however, the finance ministries in this group must also strengthen their regulation and supervision of the finance sector.
3. Countries with Favorable Conditions: Examples include Australia, Canada, Finland, South Korea, New Zealand, Norway, Singapore, Sweden, and Switzerland.
These countries are in a more stable position than the first two groups, thanks to lean governments and low levels of public debt.
Still, while many of these agencies already have a comprehensive balance-sheet approach in place for public asset and liability management, they should take risk management to the next level. In addition, these countries should champion a public-private dialogue on growth.
4. Growth Economies: Examples include Brazil, China, India, and Russia.
This group consists of emerging nations with medium to high fiscal deficits, most notably the BRIC economies. They have rebounded fastest from the crisis and have returned to warp-speed economic growth. Yet they lack adequate risk management frameworks and institutional setups, leaving them susceptible to external shocks. The finance ministries of these countries have three reform priorities. First, they should delineate and mitigate contingent liabilities. Second, they should make their economic systems more transparent. Finally, they must synchronize fiscal and monetary policymaking.
5. Countries Where Wealth Provides a Buffer: Examples include Kuwait, Saudi Arabia, Qatar, and the United Arab Emirates (UAE).
This fifth group includes emerging countries with fiscal surpluses (if revenues from hydrocarbons are accounted for), primarily those in the Arab Gulf. These economies have weak fiscal institutions that are unable to cope with the new challenges and economic paradigms that arose from the crisis. Finance ministries in this cluster should focus on identifying and mitigating contingent liabilities and balance-sheet risks, particularly those from financial exposure to foreign markets. They should also develop rigorous and transparent economic statistics at the national level, which will significantly improve the quality of policymaking. These countries have recognized that revenues from hydrocarbons will not last forever. Therefore, finance ministries should work to contain potential future fiscal deficits by aggressively improving productivity in the delivery of public services.
6. Revenue-starved Countries: Examples include Egypt and Malaysia.
This group includes developing countries with high deficits but limited ability to raise revenue, making that their most urgent fiscal issue The priorities for ministries of finance in these countries lie primarily in building stronger public finance and debt management capabilities, without jeopardizing growth.
7. Countries with Overly Decentralized Fiscal Administrations: Examples are Argentina, Chile, Colombia, Hungary, Indonesia, Mexico, South Africa, and Turkey.
The seventh and final group includes developing countries that have medium deficits and relatively low debt loads (with certain notable exceptions) but a poor track record of past fiscal and monetary reforms. These economies have a history of adopting expansionary policies that can lead to hyperinflation.
The most urgent imperatives for their finance ministries revolve around strengthening central capabilities such as fiscal management. Debt and liquidity management functions are subsequent priorities.
A Capabilities-driven Transformation Agenda
In developing a reform agenda, finance ministries will need to look not only to the external environment but to their internal strengths as well. Fundamentally, success in the post-crisis era will come from a holistic, capabilities-driven approach for transforming the means by which these ministries deliver on their expanded mandate.
Key to this transformation approach to reform are two elements—selection and focus. “Prior to the crisis, finance ministries had the luxury of being able to focus on a few initiatives at a time,” says Nabih Maroun, Partner, Booz & Company. “But in the post-crisis era, the size and complexity of the challenges have forced them to operate in all four mandate areas at once.” Finance ministries cannot choose their slate of responsibilities, and they cannot choose the economic cycle they find themselves in, but they can choose to focus on the capabilities that will make the biggest difference in how they manage those responsibilities.
A five-step process helps ministries of finance articulate their capabilities-driven transformation agenda. Specifically:
The finance ministry determines its current way to play—i.e., the approach it takes to economic oversight and intervention, supported by certain instruments, measures, and institutional setups.
The second step requires the ministry of finance to consider the implications of various potential ways to play—how successful they are likely to be and how well they fit the ministry’s current capabilities profile.
At this stage, the ministry of finance decides on its future way to play and the associated capabilities to support it. This will determine how a ministry defines the parameters of its mandate to respond to the most urgent fiscal and economic reform imperatives of the country.
This is the stage at which ideas are put into action. The finance ministry defines specific policies and intervention instruments that it will apply for the chosen mandate areas or sub-areas in which it has established a clear right to lead.
The organization will continue to frame policies and decisions in light of its chosen way to play and continuously improve its capabilities system, or alter this system to respond to new economic reform imperatives.
In light of the heavy burden of the responsibility for economic and fiscal management imposed on finance ministries by the crisis, a capabilities-driven transformation agenda will allow these bodies to rethink their operating and institutional models in a coherent and effective manner. To be precise:
More government intervention is not the answer. Rather, ministries of finance must focus on mandate areas in which they have earned a right to lead, by virtue of a capabilities system that gives them an essential advantage for managing the economic cycle.
Rationalization decisions should not be based on near-term fiscal targets. Rather, finance ministries should make cost-cutting and investment decisions based on how much certain programs contribute to national welfare and respond to the most urgent fiscal and economic reform imperatives, while preserving the government’s most critical capabilities.
Benchmarking against regional peers, on its own, is not effective in defining a country's priorities and path forward. Defining the right capabilities to develop requires a deep understanding of a country’s specific fiscal and economic conditions and a series of tough choices about which agenda items are not relevant.
Developing such an agenda will involve incorporating measures and reforms from around the world but tailoring and prioritizing them according to the ministry’s unique reform imperatives.