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public administration and development Public Admin. Dev. 29, 9–20 (2009) Published online in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/pad.509

‘IF YOU CAN’T BUDGET, HOW CAN YOU GOVERN?’—A STUDY OF CHINA’S STATE CAPACITY JUN MA* Sun Yat-sen University, P. R. China

SUMMARY State capacity matters. Using China as a case study, this essay contends that the capacity to budget is a general underpinning of state capacity regardless of how it is defined. For a state like China to enhance its capacity to budget, it must first concentrate on the issue of institutionalizing the basic controlling systems. Until this has been achieved, a move towards a more advanced budgetary system is unlikely to be successful. Copyright # 2009 John Wiley & Sons, Ltd. key words — state capacity; capacity to budget; budget reform; China

INTRODUCTION Since the 1980s, it has been well accepted that state capacity is a key factor for socio-economic development (e.g. Skocpol, 1985; Migdal, 1988). Many aspects of state capacity have been defined and examined. This essay aims to explore the issue of the ‘capacity to budget’ (Schick, 1990). This issue is important; however, there is a surprising lack of discussion relating to state capacity in the literature. It is argued that the capacity to budget is a general underpinning of state capacity regardless of how it is defined. Without the capacity to budget, state capacity would disappear or would lack any substantial content. Using China as a case study, this central theme will be examined. Since the beginning of its economic reform policy in 1978, China has been transformed from a planned economy into a market economy, forcing the state to rebuild its revenue extraction system. In the early 1990s, there was a heated debate surrounding China’s state capacity, with a focus on its extractive capacity. As a result of the 1994 fiscal reform, China saw an increase in the extractive capacity of the state. Has this been accompanied by an equivalent enhancement of the capacity to budget? This is the question this essay will address. It is contended that, before the adoption of a proper budgeting system, it was apparent that the state, though becoming richer, had not developed the basic capacity to budget. In 1999, China initiated a program of budget reform, laying a foundation for the state to develop the capacity to budget. However, the Chinese budgetary system is faced with many challenges. This article proceeds first by developing a theory about the capacity to budget. Next, it will provide an overview of the restructuring of the Chinese fiscal regime since the onset of economic reform. In the following two sections, state finances before and after the 1999 budget reform will be examined and compared from the perspective of the capacity to budget. Then, the challenges faced by the Chinese budgetary system will be addressed. The final section offers a conclusion and discussion.

*Correspondence to: J. Ma, Center for Public Administration Research, School of Government, Sun Yat-sen University, Guangzhou 510275, P. R. China. E-mail: [email protected]

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CAPACITY TO BUDGET: AN UNDERPINNING OF STATE CAPACITY The financial dimension of state capacity Whichever state capacities are defined (see Migdal, 1988, pp. 4–5; Wang and Hu, 2001, pp. 24–26), one cannot ignore the extractive capacity of the state. This is not surprising, as financial resources are the sinew of state power, and extractive capacity is ‘the foundation for the realisation of the other aspects of state capacity’ (Wang and Hu, 2001, p. 33). Nonetheless, extractive capacity is just one dimension of state finance. Another dimension that is equally important is the way the state deploys its financial resources. It is not only meaningless but also misleading to separate the two dimensions of state finance—the raising and deployment of financial resources—while discussing state capacity. In sum, as Skocpol (1985) stated, the two dimensions of state finance, when viewed as the general underpinnings of state capacity, ‘tell us more than could any other single factor about its existing (and immediately) capacities to create or strengthen state organisations, to employ personnel, to co-opt political support, to subsidise economic enterprises and to fund social programs’ (p. 17). Capacity to budget Since the 19th century, modern states began to use what is now termed public budgeting to govern their extraction and deployment of financial resources in order to achieve economy, efficiency and accountability. Consequently, budgeting became central to all state activities and served the needs of state governance well (Wildavsky, 1988; Schick, 1990). It is in this context that it has been increasingly accepted that to govern is to budget. Wildavsky (1988) titled one of his essay: ‘If You Can’t Budget, How Can You Govern?’, which is the borrowed title for this article. In 1990, Schick coined the term ‘capacity to budget’, and argued: It is no exaggeration to state that the capacity to govern depends on the capacity to budget. Without the capacity to budget, central governments could not have grown so large or come to exercise so much power. Big, active governments would be unthinkable without the discipline and regularities of budgeting. (p. 1). Following Schick (1990, 1998a), capacity to budget is defined here as: the capacity of the state to keep spending within available revenues for the purpose of fiscal sustainability; to efficiently allocate financial resources in a fashion that reflects the needs of citizens; and to efficiently collect revenues and then spend them to produce services and goods at a cost that achieves ongoing operational efficiency. In other words, the capacity to budget is composed of three basic elements: aggregate fiscal discipline, allocative efficiency and operational efficiency (see more in Schick, 1998a, pp. 2–3). The development of the capacity to budget States have long been extracting and deploying financial resources; however, they have only begun to develop the capacity to budget in the past two centuries. According to Caiden (1988), before the 19th century, state finance in Europe took the form of prebudgeting, in which states raised relatively large amounts of revenues at the expense of low accountability and administrative control. Undoubtedly, during this period, certain sorts of controls existed, and since the mid-17th century, there had been a move towards fiscal centralisation and the emergence of legislative oversight. But in general, these were far from effective in ensuring efficiency and accountability because state finances were handled through a decentralised, privatised and diversified system of separated accounts and funds. Even in the late stages of the early modern period, budgeting existed at best in an early version, lacking reliability, comprehensiveness and transparency (Webber and Wildavsky, 1986, pp. 283–297; Caiden, 1988).1 To a certain extent, the other capacities of these states (e.g. the coercive capacity) were limited by their fiscal inefficiencies (Webber and Wildavsky, 1986, p. 297). 1 For example, though England began budgeting in the last quarter of the 18th century, it did not establish full treasury control until 1866 (Webber and Wildavsky, 1986, pp. 296, 327).

Copyright # 2009 John Wiley & Sons, Ltd.

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Table 1. The development of the capacity to budget Capacity to budget

Instruments

Main features of state finance

Prebudgeting

Low or even absent

Budgeting

Basic capacity to budget

Limited accountability, little transparency, weak discipline and poor budget. Budget (in an early version) is informal and unreliable. Higher degree of fiscal regularities and discipline, the budget is formal and reliable, but little attention is paid to spending quality.

NPB

Higher capacity to budget

Lack of effective controls both within the government and over the government. Formal budgetary procedures and rules associated with administrative and legislative controls. Aggregate control; resources allocated strategically and for output/result; decentralisation.

High discretion, performance-oriented, the budget is formal, and the focus is on strategies and efficiency.

Source: Author’s compilation. Instruments in both the prebudgeting and budgeting rows are defined according to Caiden (1988), and definitions of the main features are adapted from Andrews (2007).

It was at the beginning of the 19th century that states began to develop the capacity to budget with the emergence of a new pattern of state finance—budgeting (Caiden, 1988). Budgeting, or more accurately, public budgeting, was control-oriented. On the one hand, it centralised the raising and the spending of financial resources under the purview of a single controlling authority (e.g. the Ministry of Finance) which then implemented a variety of bureaucratic procedures to uniformly constrain other agencies’ fiscal actions. On the other hand, the legislature began to oversee government finance to ensure accountability (Caiden, 1988; Webber and Wildavsky, 1986, Chapter 6). Indeed, it was largely due to the institutionalisation of the two major types of controlling procedures— administrative and legislative controls—that modern states developed fiscal structures widely perceived to be efficient and, more than ever before, fair. In this way, states began to develop a basic capacity to budget, which further enabled them to assume new functions in the late 19th century (Webber and Wildavsky, 1986, pp. 301, 326). The 20th century, particularly the period since the 1950s, has seen continuing budget reforms designed to enhance the capacity to budget, such as performance budgeting, plan-program-budgeting, zero-based budgeting and the recent new performance budgeting (NPB) reform. It is expected that the NPB, yet to emerge in its final form, will greatly enhance the state’s capacity to budget. While strengthening the constraints of aggregate fiscal discipline, the new system is intended to significantly restructure state finance in order to achieve policy outcomes by integrating budget with performance results and granting freedom to spending agencies (Schick, 1998a, pp. 12– 20; 2008).2 This historic view shows that the development of the capacity to budget has taken time and is yet unfinished. Table 1 summarises the development of the capacity to budget at distinct stages of state finance. At different stages, state finance will present different characteristics, hold different focuses, and reach to different levels of capacity to budget. To a certain extent, this framework parallels that of Andrews (2007), who describes four levels of public finance management system development. The prebudgeting phase is parallel to Andrews’ ‘level 0 system,’ the budgeting phase is parallel to his ‘level 1 system,’ and the NPB phase is parallel to his ‘level 3 system’ (see more in Andrews, 2007). The focus of this study is the transition from the phase of prebudgeting to budgeting. However, it should be noted that what is presented here is just a generalisation of major patterns of budgetary developments from the very perspective of enhancing the capacity to budget that possibly overlooks certain particularities and complexities related to specific contexts. The real world is more complex than what the framework suggests. Indeed, not every state has followed, or will follow, the same progression in the same sequence. First, to date the NPB has mainly been adopted by some OECD countries, in a variety of forms, and has

2

In Schick (1998a), this new system has another name: Public expenditure management (PEM).

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only achieved, at best, moderate successes in several of them. Most importantly, whether or not it will emerge as a universal pattern of budgeting capable of transforming state finance into a new stage remains a question that will only be answered with the test of time (Schick, 2008). However, it seems to suggest a new pattern of state finance which, if successful, will enhance a state’s capacity to budget to a higher level. Second, the transition from prebudgeting to budgeting (Caiden, 1988) has not occurred in every state, nor has it occurred at the same time. Even in European history, the adoption of budgeting varied in speed and in comprehensiveness from nation to nation.3 To a certain extent, contemporary states in some developing or transitional countries govern in a fashion that resembles prebudgeting (Schick, 1998b; Ma and Ni, 2008). For these states to develop the capacity to budget, it is critical for them to first establish a well-controlled budgeting system. Only after the rudiments of basic budgetary controls have been institutionalised, will it be possible for these states to make a move towards enhancing their capacity to budget to a higher level (Schick, 1998a, pp. 113, 122; 1998b).4 The development of such a budgeting system depends on many factors. First, a certain level of extractive capacity is necessary. When state finance is poor and revenue flow is beset by unpredictability, it is impossible for the state to even conduct meaningful budgetary activities, let alone acquire the capacity to budget. Second, only when certain economic and technical conditions have been put in place will it be possible for a state to install centralised controls, including a monetised economy, a developed banking system, a proper accounting method and a developed communication system. Lastly, but not less importantly, the sources of revenue affect state building and hence the development of a fiscal system. In terms of the sources of fiscal revenues, there are a variety of fiscal states: tribute-, domain-, tax-, trade-, tariff- (Tarschys, 1988) and rentier- (Moore, 2004) or owner-state (Campbell, 1996). In different fiscal states, the relationship between the state and society is structured differently, and consequently the revenue strategy of the state will be different. Only in a tax-state will the people develop a sense of being taxpayers, putting social pressure upon the state to demonstrate that it will wisely and accountably spend tax monies. The development of legislative oversights over governmental finance in 19th century European states that had been transformed from domain-states to tax-states from the 14th to 18th centuries was such a case (Webber and Wildavsky, 1986, pp. 296, 299–300). However, such oversights might be difficult to develop in other types of fiscal states such as a rentier-state (Moore, 2004) or an owner-state (Ma, 2005, Chapter 2), where the state is less dependent on the cooperation of society for revenues.

RESTRUCTURING THE CHINESE FISCAL REGIME SINCE THE START OF ECONOMIC REFORM The economic reforms that began in 1978 have gradually transformed China from a planned economy to a market economy. This has forced the Chinese state to re-build its revenue extraction system, and ultimately to fundamentally restructure the whole fiscal regime. From an owner-state to a tax state From the establishment of communist China in 1949 to the start of economic reform in 1978, China was an ownerstate in which fiscal revenues were mainly extracted from state-owned enterprises (SOEs) that controlled most of the wealth of society. In this way, taxation was unnecessary and it gradually became insignificant. The marketoriented economic reforms have fundamentally changed China’s economic structure, forcing the state to re-create its revenue extraction system. To extract revenues from the newly developed non-state sectors over which the state holds no ownership, the state has to use taxation. Therefore, the 1980s saw a gradual re-establishment of a taxation system in China, and by the end of the 1980s a modern taxation system had been put in place. Consequently, taxes have become a major revenue source for the state (see Figure 1), and China has been transformed from an ownerstate to a tax-state (see more in Ma, 2005, Chapter 2). 3 While England and France began to budget earlier, others started late. For example, Italy established centralized structures in 1860, Sweden after 1876, and Denmark in 1915. The USA did not establish centralized structures until 1921 (Webber and Wildavsky, 1986, p. 327). 4 This is viewed as the ‘basic first’ approach. See more in Andrews (2006).

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Revenue Share (%)

120 100 80 60

T he Share of T axes in Budget ary Revenues (%)

40

T he Share of SOEs' Net Benefit s in Budegt ary Revenues

20 0

1978 1981 1984

1987 1990 1993

1996 1999 2002

-20 -40

Year Source: Statistic Bureau of China (2003).

Figure 1. Revenue contributions of taxation and SOEs’ benefits. This figure is available in colour online at www.interscience.wiley.com/ journal/pad

This has fundamentally changed the interaction between the state and society. In an owner-state, the state was less dependent on society for fiscal revenues; instead, it was society that depended on the state for welfare. In this context, it was unimaginable that the Chinese people would demand that state finance must be accountable to them. However, as it has proceeded towards becoming a tax-state, the Chinese state has become dependent on privately owned wealth for fiscal revenues and it is increasingly faced with social pressure stemming from the concept that tax monies extracted from the people must be used for the people (Ma, 2005, Chapter 2). Indeed, the state is also committed to acting accordingly in order to win compliance from the taxpayers. Nonetheless, before a proper budgeting system has been put in place, such a commitment will lack credibility. The debate on state capacity In the rebuilding of the revenue extraction system, the issue of extractive capacity has drawn much attention. As early as the 1990s, concern began to arise in relation to ‘the decrease of two ratios’; that is, the ratio of fiscal revenue as a percentage of GDP, and the ratio of central revenue as a percentage of total fiscal revenue. In 1993, this concern became a topic of heated debate when a research report entitled A Report on Chinese State Capacity (Wang and Hu, 1993) was issued. It was contended that the state’s extractive capacity had been significantly undermined by the fiscal decentralisation and economic deregulation that had been in effect since the 1980s, which had consequently led to a decline in the state’s steering and legitimacy capacity. Therefore, a strengthening of state capacities, particularly extractive capacity, was called for, which immediately triggered fierce theoretical and policy debates within China and overseas (Wang and Hu, 2001, pp. 185–212). In 1994, partly as a result of this debate, the Chinese leadership took a big step in restructuring the fiscal system. A value-added tax was introduced in order to refine the taxation system, and this has since been the largest form of taxation. Most importantly, central–local fiscal relations were reformed by adopting a tax share system (fen shui zhi), which redirected a large amount of fiscal revenues into the coffers of the central state. Consequently, since 1994, China has seen an increase in the extractive capacity of the state, particularly the central state (Figure 2). The need for the capacity to budget Has the increase of extractive capacity been accompanied by an equivalent enhancement of the state’s capacity to budget? This question is becoming increasingly important as China is now at a crossroads in its transformation. Economic liberalisation since the early 1980s has generated amazing economic growth; however, since the mid1990s, it has become apparent that economic development has been accompanied by negative social (e.g. growing inequality) and environmental consequences that are in need of effective policy solutions. To effectively address these challenges, it is critical that the Chinese state be capable not only of extracting financial resources but also of deploying them to achieve socio-economic policy goals. Meanwhile, as China is increasingly moving towards Copyright # 2009 John Wiley & Sons, Ltd.

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20,000.00 Revenue

25.00% 15,000.00

20.00%

10,000.00

15.00% 10.00%

5,000.00

5.00%

&HQWUDO5HYHQXH /RFDO5HYHQXH %XGJHWDU\5HYHQXH*'3 %XGJHWDU\([WUDEXGJHWDU\ 5HYHQXH*'3

0.00%

               

-

Percentage of GDP

25,000.00

Year

Source: Chinese Statistical Yearbook (2007). The central and local revenues include budgetary and extra-budgetary revenues. Figure 2. The Rise of Extractive Capacity since 1994. Unit: 100,000,000 Yuan. This figure is available in colour online at www.interscience. wiley.com/journal/pad

being a tax-state, the need to legitimise the state’s raising and spending of public money has become an urgent issue. In sum, following an increase in its extractive capacity, the state must develop the capacity to budget. The Chinese leadership is not blind to the need for the capacity to budget. In 1994, the same year of the fiscal reform, China passed its first Budget Law. However, it was not until 1999 that China started a program of budget reform, aiming to establish a control-oriented public budget. Before that, even if the state had become richer, it was incapable of budgeting, as state finance was conducted after the fashion of prebudgeting.

THE PREBUDGETING OF THE CHINESE STATE: FROM 1978 TO 1999 From 1949 to 1978 state finance in China was plan-oriented, meaning that resources were allocated according to a plan and the budget served merely as a tool of plan implementation. With the onset of economic reform, the planned economy, and hence the plan-oriented state finance system, disintegrated. However, until the 1999 budget reform, no effective budget system was developed to fill the vacuum. Consequently, state finance during the period of 1978– 1999 resembled prebudgeting (Ma and Ni, 2008). On the one hand, state finance was fragmented and decentralised, without effective administrative controls within the government. Budgeting authority within the government was fragmented, manifesting itself in three aspects: (a) besides the finance department, other departments (e.g. the science and technology department) also held allocative authority over certain amounts of fiscal resources; (b) off-budgetary finance expanded rapidly from the 1980s, wherein every department extracted and then spent in discretion certain amounts of off-budgetary funds and (c) because of the lack of departmental budgets, budgetary funds were allocated in a lump sum to departments that, in turn, held a so-called secondary budgetary authority to further allocate the budgetary funds for specific objectives of expenditure. Meanwhile, financial management was overly decentralised; a single treasury account system was absent, public monies were dispersed in a variety of accounts that were opened and tightly controlled by all government units, and consequently, procurement and disbursement were also conducted by them with no outside supervision. Therefore, the finance department did not act as a central budget agency (CBA) capable of exercising fiscal control within the government (Ma and Niu, 2006; Ma and Ni, 2008). On the other hand, for many years state finance in China tended to maximise executive discretion at the expense of legislative oversight. While the government would annually submit its budget to the People’s Congress for review and approval, the budget was always compiled in aggregate totals, with little information about specific governmental activities or details of objectives of expenditure. In addition, such a budget, once approved, would be further allocated by the finance department to specific departments in a lump sum without any ex ante authorisation Copyright # 2009 John Wiley & Sons, Ltd.

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by the People’s Congress. Therefore, the People’s Congress merely acted as a rubber stamp in the budgetary process (Ma and Niu, 2006; Ma and Ni, 2008; Yang, 2004, p. 266). As state finance has continued to be fragmented, decentralised and lacking accountability, the rise of extractive capacity since 1994 has not been accompanied by an equivalent enhancement of the capacity to budget. Instead, it has been accompanied by the rampant, arbitrary and even predatory extractive behaviours often associated with corruption. This is well demonstrated in the rampancy of the ‘three unruly actions’ (sanluan)—illicit levies, fines and apportionments, which emerged in the 1980s and rose to become a nationwide fiscal problem in the latter half of the 1990s. The deployment of financial resources was much more problematic as it was persistently beset with various malfeasances such as misallocation, waste, fund diversion and repeated supplementation, as well as corruption. This is best illustrated by the rampancy of the ‘small coffers’ (xiaojinku)—secret accounts created and controlled by various public units, where the money was always used to benefit these units and their members rather than to meet the needs of the state and the public (Ma and Ni, 2008). While relatively large amounts of resources were extracted from society, most of them were not available for the state to use in order to achieve its policy objectives as they were controlled by various public units. In addition, there was no coherent budget system that could meaningfully integrate all the units of the state to act as a whole and therefore control their activities. Consequently, the best that could be established from a fragmented state finance system was a fragmented state. BUDGET REFORM SINCE 1999: DEVELOPING THE CAPACITY TO BUDGET In 1999, China initiated a budget reform composed of three major parts: Departmental Budget Reform (DBR), Treasury Management Reform (TMR) and Government Procurement Reform (GPR). As a result, the Chinese state began to develop the basic capacity to budget. Departmental budget reform The DBR requires that the government budget be compiled on a departmental basis. At the central level, the DBR was first experimented with in four departments in 2000; in 2007, all central functional departments were included in the DBR. In order to compile departmental budgets, standardised budgetary formats and procedures were designed, and all departments are required to comply with them. Moreover, the comprehensiveness principle is strictly enforced; under this, departments are required to consolidate all of their revenues and expenditures into a departmental budget. This is underpinned by an important reform named ‘Separating Revenue and Spending’ for extra-budgetary funds. In 2007, more than 90% of administrative charges, and all government funds, were consolidated. Finally, detailed objectives of expenditures were adopted in the compilation of departmental budgets. This helps to present detailed information about planned activities and relevant costs, and removes much of the secondary budgetary power previously enjoyed by the departments (Ma and Niu, 2006; Ma and Ni, 2008; MOF, 2007, p. 12). In order to reduce the influence of arbitrary decision making in resource allocation, new methods of budgeting were adopted. While basic expenditures (personnel and operation expenditures) are budgeted according to a system of fixed quota management (dinge guanli), a modified version of zero-based budgeting (ZBB) has been adopted for program expenditures spent for achieving certain policy objectives (Ma, 2006; MOF, 2007). Since 2004, some local states in Guangdong, Hebei and other places began to experiment with expenditure performance evaluation (EPE). In 2006, the central state joined this experiment (see Ma et al., 2008, p. 57). Treasury management reform The TMR aims to create a centralised treasury management system to replace the old decentralised system. It began by establishing a single treasury account system as the foundation for effectively monitoring fund flows during budget execution. Under the new system, only one treasury account is permitted at each level of government, to which all fiscal revenues collected must be submitted and from which all expenditures must be appropriated. Most importantly, before an actual payment is made, all monies must be retained in this account. Upon this, a new system named fiscal direct disbursement (FDD) was installed to centralise the fiscal disbursement; monies are now paid Copyright # 2009 John Wiley & Sons, Ltd.

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directly from the treasury single account by the finance department to suppliers of commodities and services for the government (Ma and Niu, 2006; Ma and Ni, 2008). In 2001, the new system was first experimented with in several central departments. In 2006, it affected all central departments and was extended to 3643 subunits of central departments (the number was 136 in 2001), and, for the first time, FDD was adopted for earmarked fiscal transfers to local governments. At the end of 2005, 30 provincial or provincial-level governments comprehensively carried out the reform, and extended it to more than 200 city governments and more than 500 county governments (MOF, 2006, pp. 171, 178). Government procurement reform The goal of the GPR is to create a competitive and centralised procurement system to replace the previous system, which was decentralised. First, it has centralised in the finance department procurement activities that were formerly dispersed throughout various bureaus. Second, open and competitive bidding has been adopted, although other procurement strategies (e.g. competitive negotiation) are still used. Third, FDD has been adopted for the fund disbursement of many government procurements, especially large project procurements replete with corruption scandals in the past. In 1998, the scale of government procurement was 3.1 billion Yuan; in 2005 it rose to over 250 billion Yuan. In 2004, 80.89% of government procurements were pooled, 59.55% went through a bidding process, and 39.98% were paid for through FDD (MOF, 2006, p. 171; Ma and Ni, 2008). The rise of the power of the purse Facilitated by the DBR, the People’s Congresses began to exercise the power of the purse at all levels. With the DBR, the government budget is now submitted earlier for review by the legislature, and, more importantly, the budget is more comprehensive and broken down to departmental-level details, enabling the legislature to conduct a substantial review. In 2000, the State Council submitted four central departments’ budgets to the National People’s Congress (NPC) for review. In 2007, almost all central function-based departments submitted their departmental budgets to the legislature for review. With regard to expenditure that has a significant impact on society, such as education, health care and social security, the MOF informs the NPC about aggregate totals as well as their compositions. At the local level, more than half of the departmental budgets compiled at the provincial level have been submitted to corresponding legislatures for review and approval. In 11 provinces and municipalities, all departmental budgets have been submitted to their legislatures. Most provinces or metropolitan areas have submitted to the legislatures a comprehensive government budget with detailed objectives of expenditure. More than 30 of them have submitted information about their expenditures supported by over-collected revenues, central fiscal transfers and budget adjustments (MOF, 2006, p. 171; 2007, pp. 18, 180). Consequently, the legislature has gradually, and for the first time, gained real supervisory power over the government budget, and is beginning to place checks and balances on the government’s budgetary decision making (Ma and Niu, 2006). For instance, in the 2001 annual session of the NPC, the availability of departmental-level budget details enabled delegates to scrutinise the government budget. Noticeably in that year, the legislative review particularly targeted the diversion of funds, a problem persistent in Chinese financial management (Yang, 2004, p. 267). Achievement at the local level is more encouraging. In the 2003 and 2004 annual sessions of the Guangdong provincial legislature, the people’s delegates began to fervently question misallocation of public money for private ends, asking for the reallocation of money for public goals. In the 2003 annual session in Wuhan, the legislature even vetoed two governmental program expenditures viewed by the delegates as being improper expenditures (see more in Ma et al., 2008, Chapter 3, 5, 6). The development of the capacity to budget Apparently, the goal of the reform is to create a control-oriented public budgeting system in China. The reform has begun to transform the finance department into a CBA, capable of exerting administrative control within the government. In particular, the DBR is to centralise budget authority during budget compilation, while the other two reforms begin to install a kind of ex ante control in budget execution. Meanwhile, facilitated by the DBR, the Copyright # 2009 John Wiley & Sons, Ltd.

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legislature has begun to play a substantial supervisory role in the budgetary process (Ma and Niu, 2006; Ma and Ni, 2008). The establishment of administrative and legislative controls has laid the foundation for the development of the capacity to budget. First, given the level of extractive capacity, there will be an increase in financial resources available for the state as a result of resource consolidation and centralisation. Formerly, these resources were controlled by various departments, and were not available for the state to utilise. Second, upon consolidation and centralisation, a coherent budget system has been created; it is capable of accounting for all governmental activities and related costs, and putting them under supervision. The enforcement of detailed objectives of expenditure has further enabled the finance department, the executive and the legislature to scrutinise whether public money has been allocated properly to serve public ends. Previously, nobody knew where lump-sum appropriations were spent. Undoubtedly, these enhancements are helpful for making the government visible and hence accountable. Third, the introduction of rational mechanisms such as ZBB and EPE has begun to incorporate budgetary rationality into state finance, which is helpful for improving allocative efficiency. Lastly, the enforcement of budgetary controls has paid off in constraining fiscal malfeasances (e.g. fund diversions), which had undermined budget execution before. According to a recent study (Ma and Ni, 2008), the percentage of misused budgetary funds among total budgetary funds has decreased sharply at the local level since the reform, from 38.68% in 1998 to 0.33% in 2004. WEAKNESSES REMAIN IN THE CAPACITY TO BUDGET: PROBLEMS AND CHALLENGES While much progress has been made, China remains in the early stages of developing the capacity to budget, as the institutionalisation of a well-controlled budgeting system is yet unfinished. Indeed, many challenges it is now facing are, to a certain extent, associated with this state of incompletion. Until regularities and discipline have been well institutionalised into the political process and the public administration, it will be difficult for the Chinese state to make much headway in improving its capacity to budget. Reshaping the power structure: getting the fundamentals right Since the reform, the power structure has been altered through the process of establishing administrative and legislative controls. Within the government, budget authority has begun to be centralised in the finance department, and the legislature has started to gain the authority of overseeing government finance. However, to create a wellcontrolled budgeting system, the current power structure needs to be further reshaped. The legislature needs to be further empowered. First, the Budget Law has not granted the legislature the power of budget revision. Without this legal power, the legislature always chooses to approve the government budget as a whole in the annual session, greatly limiting its ability to substantially supervise the budget. Second, many revenues and associated expenditures of the government have not been included in the budget and thus remain beyond the supervision of the legislature. These include land lease revenues, social security funds and indirect loans. Third, many large scale expenditures are still presented in aggregate totals, impeding meaningful supervision by the legislature (Ma, 2007). Within the government, budgetary fragmentation persists in certain areas largely because, despite the centralisation, the budgeting authority of several powerful departments (e.g. the National Development and Reform Commission, NDRC) remains intact. Each year, certain amounts of budgetary revenue continue to be ‘sliced’ to these quasi-CBAs, which are then allowed to allocate the funds at their discretion. Meanwhile, in spite of the consolidation of extra-budgetary funds into the budget, departments continue to view these funds as ‘their own money’ and the finance department is unable to allocate these monies as general revenue (Ma, 2007). All of this indicates that the finance department is still not a real CBA. Integrating plan, policy and budgeting The EPEs that are currently being experimented with in China are, by nature, not performance budgeting. Almost all of them are mainly an ex post performance evaluation, and no strategic plan exists to guide the choice of expenditure programs and the development of performance measurement (Ma et al., 2008, p. 59). In order to link Copyright # 2009 John Wiley & Sons, Ltd.

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budget to performance, China is faced with the challenge of integrating the budget with strategic planning and policy. The plan and budget are, to a large degree, disjointed. Although the NDRC still holds its conventional authority to develop a so-called five-year socio-economic development plan, it is no longer a leading agency of resource allocation, although it does still control the allocating authority for certain capital expenditures. Meanwhile, although the finance department is on its way to becoming a CBA, it is a CBA without the formal authority for planning. The separation of budgeting and planning functions not only generates power struggles between the two organisations but also serves to disconnect the plan from the budget (Ma, 2007). Meanwhile, policy making and budgeting remain disconnected. On the one hand, although new budgetary procedures and rules have begun to normalise the actions of departments, they are not equally effective in constraining the actions of many key actors in the budgetary process. The government, the CCP standing committee and politicians continue to act as before, making policies even after the budget has been approved by the legislature. This not only creates a major source of uncertainty in budget execution but also diminishes the role of the budget as a tool of fiscal discipline (Ma and Hou, 2005; Ma, 2007). On the other hand, in certain situations, policy is unable to be an influential tool in resource allocation. It is sometimes the case that certain policies, no matter how socially desirable they are, have not been sufficiently funded (Ma et al., 2008, Chapter 4). Had this separation continued, the state’s capacity to budget and its other capacities (e.g. steering capacity) would be under question. Managing financial transactions efficiently Since the budget reform, China has seen a reduction in the fund diversions that had previously impaired budget execution (Ma and Ni, 2008). However, as admitted recently by Zhu Zhigang, vice minister of MOF, budget execution is now troubled with a new problem: the money cannot be spent as expected. Each year, and even at the end of the fiscal year, a large amount of monies appropriated have not been spent as budgeted and have to be carried over to the next year and in some cases the year after that (see Ma et al., 2008, pp. 174–176, 180). This indicates not only problematic budget execution but also inefficient policy implementation. This is especially true when unspent funds are accumulated mainly in program budgets developed for achieving specific policy goals, and particularly in program budgets that are urgent priorities. For instance, from January to August 2007, for many programs less than 50% of the budgeted funds were spent. For example, the execution rate for health care was 44.9%, urban and rural community affairs 48.2%, and environmental protection 48.8% (Ma et al., 2008, p. 180). Unexpectedly, low operational efficiency has greatly limited the state’s ability to achieve its goals. There are many factors causing this problem. Some, for example accounting methods, are technical, and are therefore easy to solve. However, many are associated with institutional weaknesses such as the remaining fragmentation of budgeting power. Although it is required that all monies be allocated to specific objectives of expenditure at the beginning of the budget year, quasi-CBAs tend to allocate ‘their own funds’ at any time during the fiscal year. This, therefore, contributes to the slow execution of some program budgets (Ma et al., 2008, p. 174). Controlling contingent liabilities and fiscal risks Fiscal deficits have amassed since the implementation of active fiscal policy in 1998 in order to arrest the economic slow-down. The ratio of deficit to GDP surpassed 1% for the first time in 1998, and increased to 2.9% in 2000, which immediately stirred a concern of fiscal risk. However, as the state has started to step back from active fiscal policy since 2002, the ratio has begun to decline; in 2007, it was reduced to 0.8%, and it is expected to be reduced to 0.6% in 2008 (Zhang et al., 2008). Nonetheless, it is incorrect to conclude that China is free from fiscal risk. In contrast, if implicit and contingent liabilities are taken into account, it is apparent that China is faced with some potential obligations that could pose significant fiscal risks, including banking and non-banking financial sector contingent liabilities, pension liabilities, fiscal arrears, public guaranteed debts and liabilities associated with private participation in infrastructure (Krumm and Wong, 2002). In 2004, the Development and Research Center of the State Council warned that explicit and hidden liabilities at the local level have amassed to the point of fiscal risk, presenting a threat to the stability of the Chinese economy (Ma et al., 2008, p. 236). Copyright # 2009 John Wiley & Sons, Ltd.

Public Admin. Dev. 29, 9–20 (2009) DOI: 10.1002/pad

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To effectively manage fiscal risk, it is critical for China to comprehensively reform its budgetary system and strengthen its aggregate control. First, it needs to further clarify the boundary between the state and economy, as many contingent liabilities have arisen from the blurring of this boundary. Second, it needs to transform the finance department into a real CBA capable of compiling a comprehensive budget, as contingent liabilities are often associated with off-budget activities of the government. Third, it must strengthen the constraints of the budgetary process over policy making. CONCLUSION This case study of China confirms that the capacity to budget matters in the attempt to strengthen state capacity. For a state to be capable of leading socio-economic changes, it must first be capable of extracting financial resources. But this is not enough. After becoming richer, the state must develop a well-functioning budgeting system capable of consolidating all revenues and spending them efficiently to achieve policy goals and to meet the needs of citizens while ensuring fiscal sustainability. In other words, the state must develop the capacity to budget. The Chinese experience also suggests that, for a state to seek the capacity to budget in the absence of a wellcontrolled budgeting system, it is critical that the state first institutionalises basic budgetary controls in the raising and deployment of financial resources. This is the very stage that states like China cannot leapfrog over. Only after years of the effective enforcement of formal controls will the rule of law be implanted into the political process and public administration; that is, only then will officials have internalised the habits of raising and spending public money according to prescribed procedures and rules (Schick, 1998b). It is no exaggeration to state that this is the precondition for the state to conduct its budgeting in a meaningful way and hence to develop the basic capacity to budget. Unless public managers and politicians change the way they act or make decisions in conformity with formal procedures and rules established by the budget reform, budget reform itself has little justification (Ma, 2007). Only if and when regularities and discipline have been embedded into both the governing process and the budgetary process will China be well prepared to make headway towards a more advanced budgetary system such as the NPB. Of course, in order to successfully implement the NPB, some other conditions are needed while new difficulties must be dealt with (Schick, 2008). These lessons, though mainly drawn from the Chinese experience, can inform some other developing countries facing similar challenges as those China is now facing. To a certain extent, the main finding of this study echoes Schick’s (1998b) insightful call that in order to improve their governing capacities, developing countries must first concentrate on solving the rampancy of informalities by institutionalizing formal controls before experimenting with advanced budgetary systems. Recently, this kind of ‘basic first’ approach has been challenged by Andrews (2006). Admittedly, this challenge has enriched our understandings of the complexities involved in implementing performance budget reform. However, the recent Chinese experiences shall serve to re-confirm the validity of the ‘basic first’ approach. Of course, ‘budgetary basics’, though indispensable, are just a necessary condition rather than a sufficient condition for implementing a performance budgeting. As Andrews (2006) emphasises, ‘other factors’ do matter. Nonetheless, the significance of ‘other factors’ shall not lead us to deny ‘budgetary basics’ as a necessary condition. ACKNOWLEDGEMENTS

The author is grateful to Dr Matthew Andrews (Kennedy School of Government, Harvard University) and Dr Paul Collins for their valuable suggestions. This study is supported by my visiting professorship at the Department of Public and Social Administration, City University of Hong Kong and the National Social Science Foundation of P. R. China. REFERENCES

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Public Admin. Dev. 29, 9–20 (2009) DOI: 10.1002/pad