Vietnam’s Experiment with Block Grant Budgeting: "Crossing the River by Feeling the Stones"
by Ann Bartholomew, Stephen Lister, Edward Mountfield, and Nguyen Van Minh

Ho Chi Minh City is piloting a remarkable budget management reform. Launched in January 2000 and now entering its fourth year, the experiment allows local authorities considerable discretion over budget spending. A evaluation on behalf of the World Bank carried out in 2002 reported a significant increase in productivity: staffing and operational expenditures were reduced, while services maintained both their quality and quantity. This local experiment is now being extended to other parts of Vietnam.

Budget management in Vietnam was already decentralized before the Ho Chi Minh City experiment was launched. The share of local administrations in total budget expenditure reached 43 percent in 1998, up from 26 percent in 1992. Formally, provincial finance departments are required to allocate their budgets according to normative guidelines, specified by central line ministries. In practice, however, the budgets allocated to provinces were insufficient to finance all the tasks assigned by the central government. Thus out of necessity, the provinces used their own judgment in allocating between sectors and spending units. The spending units themselves, however, were subject to strict control by the provincial finance departments. The units were not allowed to reallocate spending from one item to another without the formal approval of their superiors.

This control proved to be both inefficient and ineffective. It created excessive rigidity in the allocation of resources and encouraged an approach to public service delivery that was focused on compliance with rules and red tape rather than on responsiveness and the quality of service outputs and outcomes. Detailed line item budgeting rests on the assumption that finance department officials in provincial capitals have better information than frontline service providers, or at least symmetrical information, about how best to achieve operational efficiency. Line item budgeting takes away service providers’ incentives to find savings, because savings made within items or subitems of expenditure cannot be transferred to other categories of expenditure, but must be forfeited to the treasury. Above all, micromanagement and "second guessing" of this kind blurs the lines of accountability for results between the finance function and the spending unit.

However, replacing line item control with a more flexible regime may have its own risks. Alternative checks and balances need to be in place if the move away from line item budgeting is not simply to replace one form of inefficiency with another. As external and ex ante line item controls are lifted, alternative mechanisms—such as stronger internal controls and greater ex post accountability for the use of resources and for service performance—need to be built up. Strong financial management systems are necessary if aggregate fiscal discipline is to be preserved in the absence of detailed line item controls.

Aware of the need to move cautiously with reform in this area, Vietnam chose Ho Chi Minh City as the location for conducting a small-scale pilot of the block grant approach. Vietnam’s largest city has a population of 5.27 million. It is both the richest and the fastest growing province in Vietnam. In 2001 its GDP accounted for an estimated 19 percent of national GDP, compared with less than 14 percent a decade earlier. The province is unique in Vietnam in terms of its high levels of economic activity, low levels of unemployment, and high standards of living.

Under the pilot scheme, 10 spending units were given a block grant that is fixed for a three-year period. Within these fixed budgets, spending units may choose to reallocate expenditure between line items without having to seek special permission. Spending units are free to reduce staff numbers and to prioritize between categories of administrative expenditures (with a few limited exceptions). Any savings that are made either on administrative or salary costs can be retained and used to increase staff incomes through additional salary or bonuses. Thus spending units can choose how to reduce material expenditures and can also eliminate unproductive staff, and the direct link between cost reductions and pay increases provides a powerful incentive to do both. However, spending units are required to maintain previously specified levels and standards of service.

All the spending units reported considerable reductions in expenditure on administrative items. Most of these arose from savings on communication expenses, utility bills, routine repairs and maintenance, purchases of goods and services, and printing and production of documents. Nearly all spending units also reduced their staff numbers below the official quota, with most of the surplus staff being transferred or retiring. The resulting flexibility was valuable, particularly if unexpected spending was needed. In addition, the scope for corruption was reduced. As everyone stood to gain from cost savings, there was an incentive to check that no one else was abusing the system for individual benefit.

The government is confident with pressing ahead to authorize 164 additional spending units in 19 more provinces to participate in similar experiments. The further wave of pilots will be more extensive, as it involves provinces more typical of Vietnam as a whole, and it also covers revenue-raising spending units, including key service delivery units such as hospitals and schools, whereas the initial pilots were limited to administrative units. The potential for operational efficiency gains may be greater at the front line of service delivery. Spending units will have also greater discretion in charging user fees.

This pilot program is illustrating an approach favored in East Asia, whereby many reforms are first experimented with locally, and if successful, are applied at the national level, an approach characterized by Deng Xiaoping as "crossing the river by feeling the stones." Vietnam has embarked on a path that could transform its public sector.

Ann Bartholomew and Stephen Lister are consultants with Mokoro, Ltd, Oxford, U.K.; URL: http://www.mokoro.co.uk. Edward Mountfield and Nguyen Van Minh are economists with the World Bank and can be reached at emountfield@world bank.org and Mnguyen2 @worldbank.org.