Public Financial Management:

“New Institutional Economics

Approach”

Wihana Kirana Jaya,

wihanajaya@feb.ugm.ac.id
 Introduction

 Dysfunctional PFM (predatory or contract

regime?)
 Lack of research on NIE?
 Lack of good policy ?
 Need a new paradigm?
 The NIE is “New”
 To distinguish it from the ‘old” institutional
economists such as Thorsten Veblen, John R.
Commons, Wesley Mitchell and Clarence
Ayres

 The old institutional economics was

economics with institutions but without
theory; standard neoclassical economics; and
the NIE is attempting to provide economics
with both theory and institutions
 NIE
 The new institutional economics, or NIE, is a
branch of economics that especially
incorporates various institutional constraints
into formal economic analysis in order to
explain, on the basis of rational choice,
observable real-world phenomena that
standard neoclassical economics (absent
institutional constraints) is unable to explain,
except by assuming irrational behavior on the
part of individual economic agents
 Institutions of PFM
Formal:
 Laws and regulations
 Contracts
 Constitutional laws

Informal:
 Trust
 Ethics or values
 Political norms
 Organization of PFM

 Organizations are sets of actors who

collectively pursue common objectives
 Political organization
 Economic organization
 Social organization
 Educational organization
 PFM Organization
 PFM Institutions
 Institutions are the rules in PFM that shape
the behavior of organizations and individuals
in a society

 Reforming PFM institutions are rules that

determine the non price intensives for the
behavior of individual and organizations

 Rules may solve information and enforcement

PFM problems
 LEVEL
Embedded ness:
Social theory (L1) informal institutions, customs,
Tradition, norms religion

Economics of
Property rights/ Institutional environment:
Positive political Formal rules of the game-esp. property
Theory (L2) (polity, judiciary, bureaucracy)

Transaction cost Governance:

Economics (L3) Play of the game-esp.
contract (aligning governance
Structures with transactions)

Neoclassical
Economics/ Resource allocation and employment
Agency theory (L4) (prices and quantities; incentive alignment)
The Concept of Property Right
of PFM
 There are the rights to use an asset
 The right to earn income from an asset
and contract
 The right to transfer permanently to
another party ownership right over an
asset (sell an asset)
The Concept of Transaction Cost
of PFM
 Consist of the cost of measuring the
attribute of what is being exchange and
the cost of protecting right, policing
and enforcing agreement
 Depend on human behavior assumptions
i.e. bounded rationality and
opportunism
 The Concept of Contract of
PFM
 Manifestations of intention to act or
refrain from acting in a specified way
 The choice of contracts is determine by
transaction cost, economic risk and
legal arrangement
The Concept of Agency theory
of PFM
 The relationship between two parties, a
principal and an agent who makes
decisions on the behalf of the principal
(market and hierarchies)
 Information and enforcement problems
trigger adverse selection and moral
hazard
 THE ROLE OF INSTITUTION IN PFM
Level 1: Informal institutions:
Embeddedness customs, traditions,
norms & religion

Level 2: Formal rules: esp.

Institutional property rights
Rule of the
Environment
Games of Reduce
PFM uncertainty
Business firms,
Level 3: contract system, public
Governance bureaucracies,
structures nonprofit organization
INSTITUTION
of PFM Level 4:
P & Q; incentive
Resource alignment (agency
Allocations & Reduce
theory)
Employment Transaction
Cost
Organization
of PFM
(Players)
Enhance:
1. Macro level:
Efficiency, productivity,
investment, and economic
PFM OUTCOMES growth
2. Micro level:
Efficiency, productivity,
profitability, and sustainability 13
 PEMPUS

PEMDA

-Asimetry
information
-Bargaining cost
-Principal agent
TOTAL
relationship
-Law enforcement PENERIMAA
-Hidden Action N DAERAH
-Lobbying Modus
 Application of the NIE
 States: as a network of relational
principal-agent contracts between the
constituents and their representatives
(agents)
 Theory of the State
 Contracts theory: the role of the state is
to ensure wealth maximization, efficient
regime of growth, promoting property
rights

 Predatory or exploitations theory: state is

controlled by ruling cliques or classes,
and they maximize their incomes
 Methodology
 Triangulate Data Collection
 Sampling method
 Non Parametric Data and Analysis
 Perceptions
 Empirical Discussion:
1. Fiscal Power
Own Revenue Bengkalis Sleman Score Badung Score Kupang Score
Score

Own Tax 3.4(0.9) 3.2(1.2) 3.6(0.8) 4.1(0.9)

Receipt

Charge or 3.2(0.9) 3.4(0.8) 3.5(0.9) 3.8(0.6)

levies

Local 3.2(0.9) 2.8(1.0) 3.2(0.9) 3.1(0.8)

Enterprise

Others 3.2(1.2) 3.1(0.8) 3.4(0.9) 3.6(1.0)

Note : Value and score are mean and standard deviation

 2. Local Elite behaviour
Score
Institutions Variables Bengkalis Sleman Badung Kupang
Incentive for local Government 3.8 (1.0) 3.1 (1.0) 3.3 (1.2) 3.3 (1.3)
Incentive for Local Council 3.9 (1.1) 3.1 (1.2) 3.0 (1.2) 3.0 (1.3)
Incentive for Community 4.1 (0.7) 3.4 (1.0) 3.0 (1.2) 3.4 (1.0)
Incentive for Local Private 3.7 (1.3) 3.2 (0.9) 2.9 (1.1) 3.5 (0.7)
Transparent Voter-Local Council 3.2 (1.2) 2.7 (1.1) 3.0 (1.2) 2.7 (1.0)
Transparent Local Council-Local Government 3.8 (0.9) 3.2 (1.3) 2.8 (0.9) 3.5 (1.0)
Transparent Local Government-Community 3.9 (1.0) 3.1 (1.2) 3.2 (1.0) 3.3 (1.2)
Transparent Local Government-Private Party 3.6 (0.8) 3.0 (0.9) 2.8 (1.0 3.3 (1.2)
Transparent Local Council-Private Party 3.5 (0.7) 2.8 (1.0) 2.6 (0.9) 3.0 (1.1)
Monitoring to Local Government 3.8 ((1.0) 3.2 (1.1) 2.9 (1.0) 3.6 (0.8)
Monitoring to Local Council 3.9 (1.0) 2.9 (1.2) 2.8 (0.9) 3.7 (0.9)

Value in scores are mean and standard deviation

3. Local Businessmen Perceptions
Score
Insitutional Variables Sleman Badung Kupang
Incentive positve 2.7 (0.9) 2.7 (0.6) 3.4 (1.1)
Predictability of Law 2.7 (0.8) 2.7 (0.6) 3.4 ((1.0)
Security of Property 2.5 (0.8) 2.5 (0.7) 3.2 (1.0)
Political Conflicts 3.3 (1.1) 3.4 (1.2) 3.2 (1,4)
Transaction Cost 3.5 (1.0) 3.8 (1.1) 3.2 (1.3)
Regulation on labour 2.6 (1.1) 2.6 (0.7) 3.0 (1.1)
Lobbying 3.4 (1.0) 3.3 (0.8) 3.7 (1.3)
Informal Charge 2.6 (1.1) 2.5 (1.4) 2.4 (1.1)
Competitiveness 3.4 (0.7) 3.3 (0.8) 3.7 (1.0)
Note : Value and score are mean and standard deviation
 Matrix of Correlation Coefficient,institutional assessment
( results of Spearman’s rho )

Business Lobbying Transactio Political Uncertainty Security Predictabiliy Incentive

Performance cost n conflicts regulation Property rights Of law
cost
Business 1.00
Performance

Lobbying -.08 1.00

cost (.47)

Transaction .06 .09 1.00

cost (.58) (.42)

Political -.07 .32** .36* 1.00

conflicts (.56) (.00) (.00)

Uncertainty .02 .24* -.09 .20 1.00

regulation (.08) (.03) (.41) (.09)

Security .02 .24* -.04 .082 -.07 1.00

Property (.85) (.03) (.69) (.49) (..55)
rights

Predictability .33** .09 -.25** -.10 .03 .18 1.00

Of law (.00) (.43) (.02) (.37) (.77) (.01)

Incentive .44** -.00 -.36** -.14 -.01 .20 .56** 1.00

(.00) (.99) (.00) (.23) (.91) (.08) (.00)
•Correlation is significant at the .05 level (2-tailed), ** Correlation is significant at the .01 level (2-tailed)
 Policy Agenda
More researches of NIE apply to the state:

 Continue predatory government?

 Builds on principal-agent models on new
institutional economics apply to tax system
 Builds stable, predictable, and credible
“rules of the game” in PFM reform which may
affect the overall performance of an
economy, both in the short run and long run