Designing Fiscal Institutions: The Political Economy of PFM Reforms

The term “political economy” has become ubiquitous in policy debates on public financial management (PFM) systems and their reform. Yet its definition or what exactly people mean when they use the term often remains unclear. There are many ways in which political economy has been theorized over time (Caporaso and Levine 1992). Some of these are particularly relevant for the purposes of this chapter and, more generally, for discussions around budgeting and the design of institutions devoted to the management of public finances. Broadly, we think of a political economy approach as a particular way of analyzing and interpreting economic phenomena that emphasizes the importance of political factors and vice versa. Its focus is on the different actors involved, their potentially conflicting interests and incentives, and the institutions that regulate their behavior, as well as the incentives that such institutions, in turn, may engender. More narrowly, an approach that is sometimes referred to as “positive political economy” or “political economics” has a formal and quantitative focus. The latter entails the application of methods and approaches from the discipline of economics, building on the tools of rational choice and game theory, to study the interrelationship between politics and economics (Alt and Chrystal 1983).