This is a Paper on Policy Analysis and Assessment and the author(s) would welcome any comments on the present text. Citations should refer to a Paper on Policy Analysis and Assessment of the International Monetary Fund. The views expressed are those of the author(s) and do not necessarily represent those of the Fund.

IMF Paper on Policy Analysis and Assessment

© 1997 International Monetary Fund

PPAA/97/ INTERNATIONAL MONETARY FUND

Fiscal Affairs Department

Dedicated Road Funds: A Preliminary View on a World Bank Initiative

Prepared by Barry H. Potter 1

June 1997

Abstract

In the past, Road Funds have been criticized as inconsistent with effective expenditure control, as distorting the allocation of public sector resources, and as incompatible with efficient management of government resources. This paper considers whether there is a case for a more benevolent view of the new "second generation" dedicated Road Funds, which have emerged in recent years. The paper concludes that, where a Road Fund pursues a genuine purchasing agency approach, then in principle it can be an efficient means of delivering road maintenance and, perhaps road capital expenditures. But a formidable list of institutional and financial requirements would have to be satisfied for a dedicated Road Fund to be appropriate. These conditions are more likely to be satisfied in developed economies, with efficient budgetary systems already in place. In many developing countries, the better solution may be to reform overall budget institutions, procedures and practices. But if the institutional and financial requirements for an efficient fund can be met, a Road Fund may be appropriate. The question is just how often the right conditions will arise.


JEL Classification Numbers: H54, H61

Keywords: Road Funds, Budget Management Policy, Budget Policy

Author's E-Mail Address: bpotter@imf.org


Dedicated Road Funds: A Preliminary View

On A World Bank Initiative


I. Introduction

In recent years, there has been a resurgence of interest in dedicated Road Funds. A dedicated Road Fund (RF) is normally constituted as a separate fund, outside the central government's general budgetary framework, and charged with responsibility for financing road maintenance services, and in some cases, capital expenditures. In many, but not all instances, the road maintenance element is financed, wholly or in part, from user charges rather than general revenues. The World Bank launched a Roads Management Initiative (RMI) in 1988 which, inter alia, encouraged the development of road funds. As it has evolved, the World Bank has encouraged the development of "second-generation road funds," emphasizing their transparency and accountability qualities and their financing by user charges. The World Bank seeks to establish RFs that avoid some of the problems associated with the earlier examples created in the 1960s and 1970s.

In the past, critics have often opposed the creation of RFs - primarily on grounds of inconsistency with macroeconomic (and particularly expenditure) control, as distorting the allocation of resources available for public spending, and as incompatible with the requirements of efficient cash and financial management. This paper considers whether a different view could be taken of the second generation road funds now emerging.

II. Definition of a Road Fund

It may be helpful to start with a definition of a RF found in an article by Rupert Pennant- Rae and Ian Heggie, Finance and Development (Dec. 95), describing the Roads Management Initiative, which defines the role of Road Management Boards or Road Funds, as follows.

As general principles, one cannot object to such a transparent, predictable, and accountable framework, which ought to be consistent with the requirements of good governance. Nor can one object to the principles set out in more detail in the WB technical Paper No. 275 on "Managing and Financing of Roads" on the financing of the RFs:

While being sympathetic to the principles, one might, however, be concerned about the relevance and realism of the approach, particularly in the developing countries toward which the Roads Management Initiative is targeted. The New Zealand model (as in other areas of public expenditure management) perhaps comes closest to meeting the Bank's paradigm: but does even it meet all the principles set out in the Technical Paper? By contrast, what can reasonably be required from a less developed country that wishes to set up a RF?

III. Road Funds and the Traditional Approach to

Public Expenditure Management Reform

In the recent past, IMF technical assistance missions have given their views on RFs emerging in African, Middle Eastern, and FSU countries. Such advice has typically been to avoid the creation or continuance of off-budget institutions that can undermine expenditure control and distort resource allocation. However, such advice may have reflected only the traditional macroeconomic focus, rather than taking into account certain microeconomic or institutional development perspectives. Such advice may also have been influenced by earlier responses to older-style RFs, rather than to the "second-generation RFs." For like many areas of public expenditure, transport issues require that not only policy concerns, but also certain organizational, budgetary and financial management aspects, be taken into account.

In considering the advisability of RFs, the following questions arise:

Before narrowing down the subject, it may be useful to note relevant aspects of the Fund approach to budget preparation and public expenditure management in technical assistance missions.

Yet, there are strong arguments for public sector reforms that seek to simulate the market disciplines of the private sector, and thus encourage the efficient and effective delivery of public services. These are particularly prevalent in the so-called Anglo-Saxon community - notably, but not exclusively in New Zealand, Australia, the U.S., and the U.K. These Anglo-Saxon reforms refer to several linked reforms often rooted in public choice theory and agency relationships:

This argument for capturing microeconomic efficiency gains by creating agencies is more recent, and poses particularly interesting issues. For as soon the case for creating agencies is accepted, some difficult decisions need to be taken to put in place the institutional arrangements needed for an efficient, effective, and accountable agency, while also meeting the macroeconomic, budgetary, and financial management concerns. Some of the more obvious examples include:

Can Dedicated RFs be justified only as a second-best solution when budgetary procedures have failed or are inadequate? If so, should not the focus be on putting in place efficient and transparent budgetary procedures, rather than adopting the inherently opportunistic approach of dedicated RFs?

IV. The Pros and Cons of RFs

Dedicated RFs are not an end in themselves - rather they are designed as a means of delivering efficient road maintenance services (and in some cases, capital spending). The central issue is whether, as a service delivery institution, they have some advantage over the conventional approach. Moreover, looking to the longer term in developed countries, it can be argued that they are not necessarily more than a half-way house, on the way to an approach where road maintenance is wholly commercialized and outside the public sector - rendering the issue of conventional budget versus RF no longer relevant. This may be the ultimate goal of the reforms in New Zealand.2

The practical question, however, is whether it makes sense to create such funds now, particularly in developing countries, and, if so, how they should be constituted. There are three key issues:

A. When Might a Dedicated RF be Appropriate?

The first RFs seem to have developed out of a frustration with the shortcomings of conventional budgeting. The argument was essentially that nontransparent, poorly organized, or politically dominated budgeting procedures did not deliver an adequate service. Road maintenance, as a low-priority activity with few observable benefits, was a frequent casualty in budget-cutting exercises. In-year, there could be further cuts in provision, sequestration, etc. Earmarking was seen as a successful means of securing more resources for road maintenance.

The dangers of these earmarked RFs, which secured resources for one service at the expense of others, have been widely recognized. The case for what have been termed "second-generation Road funds" seems to be broader. According to the paper by Gwilliams and Shalizi, it has two components. First, such RFs can "...compensate for political or administrative myopia and ensure the allocation of resources to a low profile economic activity with particularly high rates of return." Second, there are the microeconomic efficiency arguments for such funds, essentially those which favor an agency approach, with some form of user-charge financing.

While the analysis is appealing, the implications and interactions between the two arguments need to be carefully thought through. For in practice, it seems that a RF is less one single, well-defined institution than a number of different arrangements which may be usefully subdivided into several different models:

Funds like the U.S. Trust Fund for highway construction (1) are longstanding and not relevant to the RMI. It also seems to be common-ground that category (2) - old-style first-generation RFs - are to be eschewed. That leaves (3) the FSU models; (4) the pure agency model; and (5) the more complete Dedicated RFs.

To sum up, one might want to pursue RFs only:

B. Organizational Issues in Establishing a RF

In institutional terms, the advantages of RFs are clear. They provide a predictable source of finance for the maintenance and, under some models, the construction of roads. Too often, governments pressed for budgetary resources reduce the roads maintenance budget first, and the capital budget second, when the call comes for expenditure cuts. Road maintenance has a low priority because few perceive the benefits and the cost of inadequate maintenance is not always immediately obvious. Developing countries may have little incentive to provide maintenance, if they think a donor will always come along to rescue them.

There can also be important transparency and accountability advantages in dedicated RFs. Transparency is enhanced to the extent that an appropriate objective-setting and performance measurement framework is adopted, complied with, and audited externally. The user charge can form a link between level and quality of service and price. Accountability is enhanced through the creation of a management board - particularly when the average Minister of Transport's tenure is typically less than the average time to construct five or ten miles of a new road.

With the right sort of administrative and financial management arrangements, RFs can enjoy the wider benefits of the agency model: the freedom to focus on service delivery and the resultant greater efficiency and effectiveness this provides.

Yet one must also acknowledge that there can be a huge gap between the above theoretical advantages and the actual experience of an agency. Some key questions have to be asked of any RF being set up:

C. Financing Issues

While the examples in the UK and New Zealand have shown the considerable benefits of RFs, they have very different approaches to the financing. At one extreme, the U.K. agency is still wholly financed from general revenues. Theoretically, the absence of a link between sources of finance and the level and quality of services detracts from the benefits of such a model - in the sense that even more benefits could be gained, if there were also a user charge. In New Zealand, the RF is principally financed by user charges. While the agency benefits may be maximized in such an arrangement, when the financing is wholly or in part from user charges, there are potentially worrisome aspects from macroeconomic, financial, and budgetary management perspectives.

Dedicated RFs have traditionally been financed by a two or three part tariff:

In principle one can thus envisage the first source of user charges going to meet the cost of capital investment in the road network, while the second is related more to maintenance expenditures.

The application of user charges has a large number of theoretical attractions: to quote from Pennant-Rae and Heggie: "Revenues earned from the three financing mechanisms, which together would constitute a road tariff, could be funneled directly into a Road Fund for spending on maintenance as well as on new construction."

In practice, however, there may be some drawbacks:

V. Conclusion

In summary, a Road Fund is not appropriate where it represents the earmarking of general revenues for one purpose, with the service delivery still pursuing a traditional model. Where a RF is a genuine attempt to pursue a purchasing agency approach, then in principle, it might be desirable. Whether it is desirable in practice will depend on certain institutional and financial conditions being met.

Can we define those certain conditions? Some minimum requirements can be applied.

Ideally, one might also want to see a high degree of cost recovery through user charges. The theoretical attraction is clear. But, in many, if not most cases, this is unlikely to be possible, at least initially. In such cases, one would wish to see any general transfer, whether from central or local government sources, to continue to be subject to normal government budget disciplines. There must be no RF which is guaranteed some share of total tax revenue to which is added the money generated from user charges.

Finally, however, one must be cautious in constraining the capacity of countries to raise fuel duties as a means of increasing general revenues. Inevitably, that would put a burden on government and the authorities of the RF to explain, at a minimum, why all petrol price increases are not created equal. It may also mean that, for some developing countries, where fuel charges are a particularly important source of tax revenue, RFs may simply not be appropriate.

To sum up, the desirability of dedicated RFs in the future needs to be assessed on a case-by-case basis. Provided the right conditions are met, RFs can be endorsed in practice as well as in principle. The question is just how often the right conditions can be met.


FOOTNOTES

1 An earlier version of this paper was presented to the World Bank Transport Forum in Chantilly, Virginia, in April 1997. The Author is grateful to Peter Heller, Adrienne Cheasty, and Ian Lienert (FAD) ans Zmarak Shalizi (World Bank) for helpful comments.(return to text)

2 See R. Toleman, "Road Transport: How Much Does Government Need To Do."(return to text)

3 On the other hand, some of the agency arguments would seem to suggest the broader responsibility would be appropriate, at least in the developed countries, for creating the asset and then maintaining it.(return to text)


REFERENCES

Gwilliams, K.M., and Z.M. Shalizi, "Road Funds, User Charges and Taxes," World Bank

Pennant-Rae, R., and I. Heggie, "Commercializing Africa's Roads," in Finance and

Toleman, R., "Road Transport: How Much Does Government Need To Do?," Paper

Heggie, I., World Bank Technical Paper No. 275 "Managing and Financing of Roads: An