Sustainable Public Financial Management

Doug Hadden, VP Products

Make sure you calculate the Return on Investment of open data projects. Experts warn us: the open data business case is often lacking. Traditional ROI calculations are too narrow.

Traditional ROI Calculation and “Government as Platform”

A traditional calculation compares open data costs and lost revenue from selling the data relative to additional tax revenue achieved. Tim O’Reilly  coined the notion of “government as platform” where open data (such as GPS) generates significant economic development. Some, like Andrea di Maio, disagree that governments should be acting as platforms.  Yet, this is what governments do: build economic platforms such as highways and bridges.

The problem with:

$TaxRevenue > $OpenDataCost + $DataSales

is that the government organization that provides data and benefits directly from selling the data to the private sector does not directly receive the additional taxes nor can these taxes be easily directly attributed to open data.

1. Economic Development and “Government as Platform”

Open data as policy can be compared to stimulus programs. Stimulus programs can improve employment and reduce bankruptcies. This reduces social services costs:

$TaxRevenue + $SocialServicesCostAvoidance > $OpenDataCost + $DataSales

2. Freedom of Information Costs

David Eaves has pointed out that open data can reduce the costs of Freedom of Information:

So in a world without an open data portal the hypothetical cost of fulfilling these “Canadian” downloads as formal access to information requests would have been $967,184.46 in January alone. Even if I’m off by 50%, then the cost – again, just for January – would still sit at $483,592.23. Assuming this is a safe monthly average, then over the course of a year the cost savings could be around $11,606,213.52 or $5,803,106.76 – depending on how conservative you’d want to be about the assumptions.

Open data portals can eliminate the need for many Freedom of Information requests – a high cost to governments.

$TaxRevenue + $SocialServicesCostAvoidance + $FOIAvoidance 
> $OpenDataCost + $DataSales

3. Productivity

Open data shines light on the public service. Although transparency does not necessarily mean accountability in the sense of enforcement, it has the power to change behaviour. Government organizations become aware that the public is watching. Civil service behaviour changes.

$TaxRevenue + $SocialServicesCostAvoidance + $FOIAvoidance + $ImprovedProductivity 
> $OpenDataCost + $DataSales

4. Corruption

Procurement expert Jorge Claro estimates that procurement corruption costs up to 20% for governments in developing nations. That’s why countries like Timor-Leste open budget and procurement data: to improve oversight by vendors and civil society to reduce corruption. (This also reduces the cost for auditors when the press is examining all large government purchases.)

$TaxRevenue + $SocialServicesCostAvoidance + $FOIAvoidance + $ImprovedProductivity + $ReducedCorruption

> $OpenDataCost + $DataSales

5. Trust

There remains a distrust of government in many countries. Not just in developing countries: distrust of government is a powerful narrative in American politics. The distrust in government can boil over to protest (Tea Party, Arab Spring, Occupy Wall Street etc.) This costs governments – although the release of data might give cause for protest in some cases!

$TaxRevenue + $SocialServicesCostAvoidance + $FOIAvoidance + $ImprovedProductivity + $ReducedCorruption +$ReducedProtests

> $OpenDataCost + $DataSales + $IncreasedProtests

6. Tax Compliance

Developed and developing nations alike struggle with tax avoidance. This is especially rampant when citizens believe that governments are wasting tax money. This is often made acute because of the lack of open data. There are frequent studies that show a significant delta between how governments spend and what citizens think governments are spending. In particular: foreign aid and crime. One can make the argument that Scandinavians are less concerned about high tax rates than Americans because they see value.

$TaxRevenue + $ReducedTaxAvoidance $SocialServicesCostAvoidance + $FOIAvoidance + $ImprovedProductivity + $ReducedCorruption +$ReducedProtests

> $OpenDataCost + $DataSales + $IncreasedProtests

7. Reduced Perceived Business and Donor Risk

Transparency is fundamental in many governance valuations used by the World Bank World Governance indicators (WGI) and the Millennium Challenge Corporation (MCC). Transparency indicators used to demonstrate reduced business risk and help generate donor funds in developing countries include Open Budget Index for open budgets and Revenue Watch Index for revenue transparency from extractive industries. International transparency standards include the Extractive Industries Transparency Initiative (EITI) and the International Aid Transparency Initiative (IATI). Public Expenditure and Financial Accountability (PEFA) assessments are gaining widespread use by donors in making funding decisions. Transparency is a key element for 6 measurements in the PEFA Performance Measurement Framework:

Transparency can reduce perceived business and donor investment risk in developing countries. This increases taxes, improves outcomes and ultimately improves credit ratings.

8. It’s a Network

ROI in the physical world is a diminishing returns calculation. Each new market for toothpaste increases costs. The virtual world is one of increasing returns. Each new chunk of open data adds value to previous chunks of open data. And the costs to collect and maintain open data goes down because the infrastructure scales. (That’s why Amazon can provide such value for the Elastic Cloud.)

∑($TaxRevenue + $ReducedTaxAvoidance $SocialServicesCostAvoidance + $FOIAvoidance + $ImprovedProductivity + $ReducedCorruption +$ReducedProtests)↑increasingreturns

> ($OpenDataCost + $DataSales + $IncreasedProtests)↓reducing costs

Conclusions

The ROI calculation is a bit mangled here. Yet, there is a compelling value proposition for government organizations to take the open data journey. The calculus depends on the country situation – in some cases open data can pay for itself thanks to reduced corruption or protest.

Global Poverty

Entertainer and activist Bono tells the Globe and Mail to forget the past mistakes in foreign aid. “The present aid is working” [video]. This is a contrast to the ‘aid is just a waste of money’ and ‘it’s better to give at home’ narratives promoted by some politicians in developed countries.

As Owen Barder has pointed out:  most people don’t need to be convinced that development is desirable; they need to be convinced that aid works. However, rising budget deficits have given rise the notion of reducing foreign aid.

Developed country governments have fallen short of past commitments and now more is threatened. This has created concern in the aid community as reflected by the Modernizing Foreign Assistance Network in the United States who pointed out:

For around 1% of the federal budget, experts from the United States Agency for International Development (USAID), the Millennium Challenge Corporation, and other agencies are empowered to work hand-in-hand with our diplomats and members of the Armed Forces to help build accountable institutions and increase stability in “frontline” states like Afghanistan, Pakistan, Iraq, Somalia, and Yemen.  These professionals are also deployed to help boost private-sector and middle-class growth and reduce poverty in developing countries, the fastest-growing markets in the world. Our development efforts in these countries are crucial to opening up export opportunities for American businesses and building stable, long-term trading partners and allies. Were we to pull back, the void left behind would surely be filled by other countries that do not share our values.

Cutting aid may reduce security in developed countries as pointed out by US Secretary of State Hillary Clinton. Much of the security and aid debate relates to military and government aid to maintain stability. But, it is clear that improving the economic conditions of any country increases stability.

Towards a Rational Aid Debate

Aid targeting the sources of poverty and instability could be orders of magnitude more effective than securing borders and building intelligence and military capacity. Fixing the symptom is typically less expensive that mitigating the problem.

Foreign aid may also have more impact than local aid – especially with so many people living in poverty.

There is no question that aid effectiveness could improve. This is one of the benefits of the International Aid Transparency Initiative. The international community is improving results and leveraging transparency. There is a growing recognition of the power of harmonizing aid with government priorities and the need to untie aid.

But what about the other 99% of government budgets? Is there the same scrutiny to improve outcomes for national investment? It seems as if politicians are willing to promote spending based on inputs (the money provided for projects) rather than outcomes, with techniques such as “earmarks“.

Don’t get me wrong, there remain opportunities to improve aid effectiveness. Transparency data with visualization techniques holds much promise. It might be time for governments in developed countries to improve outcomes for internal national programs too.

Doug Hadden, VP Products

Richard Allen provided interesting insight into whether development partners should use country financial management systems on the IMF PFM blog. Mr. Allen describes the risk associated with doing so and provides a prescription of how country systems can be used. The main focus of the article was on Sub-Saharan Africa.  I provided some comments on the IMF PFM blog that I expand below. FreeBalance is one of the major providers of government Integrated Financial Management Information Systems in emerging nations.

The implicit governance equation used when considering using country financial management systems can be troubling. Donors rightly identify the risks of using these systems: corruption, inefficiency, errors and so on. One can often focus on the risk of change without considering the benefits. Governments in Sub-Saharan Africa can question whether the minimum target for PFM quality is set too high. The equation often does not consider the inefficiencies of the current aid regime. There seems to be an “all-or-nothing” view for using country systems within the aid effectiveness community. Practical solutions for phasing in the use of country systems are available. Mr. Allen advanced the discussion in pragmatic terms.

What should the target be for PFM quality and effectiveness?

Governments around the world are reforming PFM processes. Many G7 countries have not achieved unqualified audits in the past decade. The Government of the United States does not account for trillions of dollars of long-term liabilities. Aid partner financial systems have also been shown to be flawed. Governments in Sub-Saharan Africa should not be expected to have better systems than the G7 or donors.

A practical minimum target should be set. This means “clear performance targets” as indicated by Mr. Allen. PEFA may be ideal. But, there is some concern about the application of PEFA. Many emerging nation governments see the value of PEFA for internal assessments but not necessarily for external assessments. Millennium Challenge Corporation indicators come from multiple sources but these may be too high level to be prescriptive.

Why should alternatives be costed?

Country PFM systems can be inefficient and prone to corruption. Some estimates show that inefficiency costs governments up to 20% in government procurement. Estimates suggest that corruptions costs up to an additional 20%. Yet, aid transaction costs could be even higher. (The material about aid transaction costs is mostly anecdotal.)

Aid executed by third parties in countries can be particularly inefficient through high sub-contracting, foreign personnel and reporting costs. Aid distributed to government agencies suffers from the same inefficiencies as country systems with the added problem of reporting costs. Poor outcomes result because of the lack of donor and government coordination. The question of whether to use country systems should focus on the notion of cost per unit of outcome. This can be unrealistic in most countries, so the cost per unit of output should be used temporarily.

Why phase in country systems?

Sequencing PFM reform is considered a best practice by the vast majority of experts in the fields. The aid effectiveness community is pushing for aid harmonization and the use of country systems, as indicated in the article. The Accra Agenda for Action (AAA) and Paris Declaration represent core beliefs for aid effectiveness. The aid community wants, as Mr. Allen points out, “donors to channel their lending through budget support operations, and similarly to use country systems for aid and investment lending operations.”

Some donors should try to use country systems to encourage governance. The European Community methodology where “aid resources can be clawed back by the EC if countries fail to meet” criteria can be used to ensure compliance. This provides practical experience for governments. Donors can mentor governments.

What about commitments and disbursements?

Effective outcomes are compromised when donors do not disburse promised aid. Sometimes this aid is not provided to governments because conditions were not met. Donors need to help governments to account for these liabilities within financial systems.

Government systems often appear to be black boxes to development partners. There is a focus on actual expenditures rather than the commitment cycle. Aid is often delayed because of inefficiencies or through disciplined fiscal procedures. Donors and governments need to know the commitment progress: purchase requisitions, civil service recruitment procedures, purchase orders and goods/services received for aid projects. This can be accomplished through country financial systems at low transaction costs relative to current methods.

What about COTS software?

The leading vendors of Commercial-Off-the-Shelf government financial management software provide comprehensive audit trails. Reports can be created from these systems in an encrypted manner, resilient to tampering and made available to donors. Among others, Ghana, Malawi, Sierra Leone, Tanzania, Uganda and Zambia use COTS software. COTS software does not eliminate inefficiencies or corruption. It does reduce errors, improve efficiency, and provide audit trails to uncover potential corruption.

Some Conclusions

The advantages of using country systems to manage aid disbursements exceed disadvantages in most cases. And, participating in the country systems enables development partners to assist governments to improve governance.