Balancing a government’s budget is difficult in most countries at most times. It is virtually impossible in the immediate aftermath of a significant conflict. During the conflict the government will probably have incurred massive deficits and tried to cover them through printing money at an exponentially increasing rate, thus robbing the national currency of most of its value. The war may also have reduced the country’s economic output to a fraction of its pre-war level, leaving not much income and business turnover that can be taxed. To make matters worse, whatever taxes are still due can probably not be collected because the fiscal administration has collapsed.
At the same time, legitimate demands on the government’s budget are higher now than before the war. In addition to the cost of resuming normal government operations, the war has created large additional demands, mainly in two forms: major damage to public infrastructure results sometimes more from years of neglect than from shelling and bombing, but whatever the cause, it needs to be repaired. More importantly, the war has left many victims in addition to the dead: the homeless, the displaced, the sick and the unemployed all need help to survive.
With some luck, the international community will pay for the cost of humanitarian assistance for, maybe, two years, and will provide food aid even beyond that date, as long as the U.S. and the E.U. have to dispose of large quantities of surplus food generated by their large domestic subsidies to agriculture. The international community may also pay for most of the cost of repairing important public infrastructure and maybe some less important infrastructure if it suits a donor country. The real immediate budget problem is therefore the financing of regular government operations, which donors don’t like to finance for reasons that are not entirely clear. Mainly, it seems there is no political constituency in donor countries for financing recurrent government expenditure in countries of dubious reputation where corruption is considered to be widespread if not endemic.
Elected politicians in donor countries are understandably worried about not having their name associated with the tax payer’s money being diverted to some Swiss-type bank account instead of paying for teachers’ and nurses’ salaries in a post-conflict country. By contrast, feeding the starving masses with surplus food and selling equipment to generate employment at home are well received by special interest groups and are considered to be unobjectionable by the electorate at large.
How, then, is a post-conflict government to pay for the most urgent recurrent expenditures such as the salaries of a core civil service to administer the country and of judges, policemen, teachers and nurses and doctors? The simple answer is: many of those salaries may not be paid for a fairly long period, maybe a year, or will be paid at such a low level that they discourage honest work. That, of course, is a prescription for anarchy, out of which will arise either a failed state, or renewed war, or both, as has happened sometimes, as in Congo and Somalia. To prevent that from happening, two avenues must be pursued: budgetary commitments must be kept to a minimum, and some permanent sources of revenue must be found.
On the expenditure side, the largest items tend to be the payroll and associated cost of the military, the schools, and the health system.
Regarding the army, our recommendation is: keep it small and simple, even very small and without sophisticated weaponry that entails major cost in training, maintenance and operations. Advocates of a large army with sophisticated equipment generally argue that it is needed both for internal and external security. These advocates are wrong on both accounts: internal security is not the army’s business, but that of the judiciary and the police force, both of which should be relatively generously funded in terms of both numbers of staff and level of pay to ensure establishment and maintenance of law and order. External security, on the other hand, can in most post-conflict countries not be achieved through military strength, but only through diplomacy, good or at least non-hostile relations with neighbouring countries, and, if necessary, recourse to the international community. Most post-conflict countries are simply too weak to seek security through military strength. This being said, a small but efficient and mobile army is an important instrument for the government to protect itself against adventurers and rebels from inside and outside the country. In practical terms, the equivalent of one or two divisions should suffice for this purpose.
The worst possible situation is one of multiple armed forces, as in Bosnia and Afghanistan. In the case of Bosnia, the three warring parties -Bosnian Muslims, catholic Croats and orthodox Serbs- didn’t agree on much during the peace negotiations in Dayton, Ohio, in late 1995, but they agreed that they each wanted to keep their own army in the newly created Federal Republic of Bosnia and Herzegovina.
Oddly enough, the U.S. negotiators who chaired the peace conference granted that outrageous request. Now, eight years later, there are still at least two effectively independent armies in the country, and so is a major NATO peace-keeping force, in order to prevent the old enemies to get back at each other’s throats and ruin whatever progress toward stability and well-being has been made in the last eight years. Had there been only one small army from the beginning in 1995, much money spent on the military could have been used productively, such as for improving education and health services. Even more important, the local political leaders might have understood that they did not have a choice but to live with each other, and might have chosen to make the best out of a situation not to their liking. Instead, after all these years, the country is still ethnically divided and the local political leaders do everything they can to keep it that way, much to the detriment of social and economic development and at the price of Bosnia continuing to remain politically and militarily under international tutelage.
In Afghanistan, on the other hand, only one army exists officially, but its existence is mostly virtual, mainly due to lack of funds. However, each important and influential local chief seems to have his own private army, or militia, for a total of about 100 000 armed men, compared to less than 5 000 in the government’s army (IHT, 16-05-03). These militias were initially financed and armed by the U.S. government, with a view to get their help in the war against the Taliban and Al Qaida. While this help may have been effective in the war against the Taliban (but not against Al Qaida, where not much was achieved in Afghanistan), it certainly was effective in creating self-sustaining regional fiefdoms that levy their own taxes (and have the necessary muscle to enforce payment). Due to the lack of effectiveness of the central government in this situation Afghanistan rapidly regained its position as the world’s leading supplier of opium, with a market share estimated at about 75% and foreign exchange revenues far in excess of one billion dollars, even assuming a very low export price. It is fair to assume that the local chiefs collect a large share of this money in their coffers and have no problems in paying regularly their soldiers and civil servants, something the central government is unable to do, in spite of all the promised international assistance.
There is little prospect for this situation to improve in the next few years because Afghanistan seems to be fairly low on the priority list of the major international powers. As long as that remains so, the most probable outcome is a further decline of the central government and renewed outbreak of hostilities between rival groups.
Adequate budgetary funding of education and health services poses a serious dilemma for all but the richest post-conflict governments: everybody agrees that adequate funding of education and health services is of the highest importance and constitutes much of the entrance fee to a happier future. However, this is nearly always far beyond the means of the newly established government. Consequently, priorities must be established and painful choices must be made. The highest priority by far is funding of primary education and basic health services. All experts agree that this is true on grounds of both equity –trying to give everybody a fair chance in live- and efficiency –a dollar spent at the primary level produces much more benefits than the same dollar spent at higher levels of the system. Universal primary education and basic health services should therefore be fully funded from the national budget and should be provided free of charge. That, of course, will not leave a great deal of public money for secondary and tertiary education and health services, certainly not enough to provide them free or nearly free to all who want to use them. The resulting problem of allocation of scarce funds has traditionally been solved in the simplest fashion: the governing elite has used its power to allocate the resources available for secondary and higher education and for advanced health services to itself and its children. That is true today in most poor and relatively poor countries, where primary services are frequently deficient while universities and modern hospitals care for the rich and their children.
The upheaval of war and its aftermath may provide an opportunity to introduce a more equitable and more efficient system for allocating scarce funds. Charging for services other than primary services is probably the only efficient way to do that. Any other system of allocation is open to distortion by the rich and powerful, except of course in countries that are rich enough to provide free education and subsidised health services for all –not normally the case in a post-conflict society.
Since law enforcement is one of the most urgent and important tasks of any new government, it is obvious that money must be found to pay judges, prosecutors and policemen, and to pay them well enough that they can afford to be honest and don’t need to rely on bribes for a decent living. The same applies to the rest of the civil service: a small, but adequately paid staff is vastly preferable to a large one which is poorly or irregularly paid and spends most of its time on finding ways to supplement salaries insufficient to feed their families.
Two other areas need attention: state-owned enterprises and the social safety net. In too many countries, profitable enterprises are privately owned and loss-making enterprises are owned by the state. Among the various reasons for this phenomenon is the fact that ownership matters: the state as owner tends to interfere in enterprise management in various detrimental ways, mostly under the guise of so-called “social obligations” by keeping prices, mainly of public utilities, low and having the tax payer cover the losses while adding unnecessary staff to the enterprise payroll to satisfy the needs of nepotism and bribery through selling jobs. The financial emergency and budget problems that come in the wake of an armed conflict provide a good opportunity to break with the bad habits of the past. Outright privatisations are rarely an option in the early post-conflict period, because investors are initially only interested in the most profitable ventures with the quickest payback, such as mineral deposits and mobile phone licences. But there are other options open to a reform-minded government: the simplest one is the “hard budget constraint”, to use the Hungarian economist Janos Kornai’s phrase: enterprise managers are being told that they are free to manage as they see fit, but will not receive any subsidies, or only those to offset clearly defined public service obligations (such as providing a minimum service of power, water, etc. at prices that are affordable to the majority of people).
The most important aspect of this approach is of course that it must be credible. If it is not consistently applied, it rapidly looses credibility and effectiveness.
A less accident-prone but more complex solution is the negotiation of concessions with foreign partners. They come in a fairly large variety of forms reaching from the operation of a public utility for a limited time to something close to the full transfer of ownership for an extended period.
Even in the moderate variety, taking a concession implies a wager on the country’s future stability and development. A reasonable allocation of risk between the contracting parties is the key to a satisfactory long-term relationship. Each party should carry the risks they can best control: the government, political risk and the concessionaire, management and commercial risks.
In practice there is a lot of overlap between these areas and it takes a fair amount of common sense and good faith to agree on solutions that withstand the test of time. At the same time, negotiation and implementation of concessions give the government the opportunity to establish a track record of being a reliable partner with whom to do business. That, in turn, will attract more investors both for concessions and for the purchase of equity, both government-owned and privately held (see also Chapter 8).
The poorer of the poor countries generally don’t have a state-sponsored social safety net. Family and tribe, where still intact, provide some of these functions. Others, mainly the urban poor and the displaced, may be without any support, except for the usual post-conflict humanitarian assistance provided mainly by NGOs.
Unfortunately, the newly formed government will probably not have the financial means to do much about that. It should, however ensure that foreign humanitarian aid reaches the poor rather than enriching the rich as happens all too often. This is no trivial undertaking because each country has influential groups that will try to “monetize” humanitarian aid for their own benefit by gaining control over its distribution and selling all or part of it on the market.
The rigorous action by both, donors and the new government, needed to prevent that from happening, has only rarely, if ever, been taken in the past. This, one hopes, will change in the future.
Where a post-conflict country had in the past a state-sponsored safety net for providing pensions and insurance for health and maybe unemployment, the question is how to re-vitalize a probably moribund system.
At issue is the level of payments to the retired, the unemployed and to welfare recipients. Wartime inflation will probably have strongly eroded the real value of payments, but simply revaluating them to bring them back in real terms to the pre-war level is probably unaffordable. What should be done, if at all affordable, is to establish a minimum level of payments as a function of family size that allows beneficiaries to stay out of dire poverty. Much more than that is probably not possible in the short to medium term.
Even if public expenditures are kept to a minimum as outlined on the previous pages, they will still add up to a substantial package, maybe 20% of GDP or even somewhat more, and that just for current expenditures, excluding any of the cost of reconstruction or other investment expenditures.
Post-conflict countries, like other countries, have to rely on taxation for most of their revenue. Given the administrative weakness of the new government, the use of sophisticated forms of taxation, like value added and income taxes, is out of the question for at least a few years. Only the simplest forms of taxes, like excise taxes and import duties, are administratively feasible. But even a simple regime of, say, excise taxes on mineral fuels, alcohol and tobacco together with a uniform ad valorem import duty is difficult to manage. First, there are the smugglers who will bribe the border police and customs officials and try to find unsupervised border crossings. Second, there are the donors who refuse to pay import duties on what they bring in the country because they don’t want to finance the government’s budget, not even indirectly.
Between the smugglers and the donors, maybe half the tax base evaporates and the rest is probably insufficient to balance the budget.
Traditional sources of public revenue, other than taxes ad duties, tend to be either unavailable or unadvisable to a post-conflict country. Commercial borrowing is generally out of the question because most post-conflict countries are not creditworthy. Privatising state property is also not an option because potential investors will either offer ridiculously low prices or, if they are serious and honourable people, will want to wait a year or two to see if there is a reasonable prospect for stability in the post-conflict country.
Selling licences for the exploitation of natural resources and the radio spectrum –mainly for mobile phone services- can produce some revenue but must be handled with care because of the enormous potential for corruption and for mismanagement of the country’s natural endowment. Contracts for licences and concessions should be carefully prepared and should be awarded in a competitive process. That can take anywhere from three to twelve months, and sometimes more. In the meantime, no revenue is available from this source.
Quite a few post-conflict countries have significant potential revenue from the export of minerals, timber or other resources. Competition for these revenues may in fact have been a principal cause of the war and could well generate a renewed outbreak of violent conflict. Avoiding that risk is simple enough on paper: all financial transactions should be entirely transparent and all revenue from royalties etc should accrue to the general budget to the exclusion of any special funds. In practice, this ideal solution has rarely, if ever been achieved, and if so only in a mature, peaceful democracy like Norway. In any post-conflict country all powerful groups and individuals can be expected to try very hard to secure as large a share as possible of this revenue for themselves and their groups. Preventing that from happening and ensuring that at least most of this revenue is available for the state’s budget will be a test of the new government’s ability to function. If the government fails this test then there is not much hope that it will do better on other critical issues, and the countdown for renewed violent conflict may have started.
Donors are generally unwilling to finance current expenditure because they are concerned about corruption and because they want their contribution to be visible. The principal exception to that rule is the World Bank that does provide a portion of its funding, maybe a quarter or even a third, to finance current expenditure. However, there are two constraints: some of this money may be needed to pay debt service due to the World Bank, and the World Bank will want to be convinced that the government’s budget is reasonable on the expenditure side and that planned expenditures are roughly in balance with revenues expected from difference sources. Similar conditions apply to financial assistance from the IMF.
Financial assistance from both the IMF and the World Bank is of course available only if the post-conflict country is a member in good standing of both institutions. That means in practical terms that the issue of payment arrears to both institutions accumulated during the conflict has been resolved. This is no small matter and requires various kinds of creative financing, but a solution is always being found if a sufficiently large part of the international community is interested in stabilising the post-conflict country. In Addition, partial or total debt forgiveness, including debt to the World Bank and IMF, happens more and more frequently.
Despite these various forms of revenue and financial assistance, the new government may find itself victim of a vicious circle: to increase revenue one needs to hire more, better, and better paid customs officers and border police; that, however, cannot be done because public revenue is insufficient. Public revenue is probably also insufficient to provide adequately for internal security, that most important item of the first hour of transition to peace.
Anecdotic evidence suggests that many of the repeater wars could have been avoided if the international community had for a limited period of a few years provided the relatively small sums of general budget support that may make the difference between war and peace.
The need for budget support by international donors is one of the most important conclusions coming out of this study. Safeguards, such as financial controls by independent experts, could be relatively easily put in place to prevent money from being stolen by corrupt officials. Donors may want to delegate the rather unpleasant activity of financial controls to the IMF and the World Bank.
Budget support provides in fact an excellent vehicle to increase stability and reduce corruption. Budget support also buys donors a seat at the table of government decision making for all public expenditures, not only the part they finance, because money is fungible.