15-10 Assessing the operational environments of public financial management system in Korea

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(2) Korea Institute of Public Finance 336, Sicheong-daero, Sejong-si, Korea Tel: 82-44-414-2114 Fax: 82-44-414-2179 URL: www.kipf.re.kr C 2015 KIPF ◯.

(3) Assessing the Operational Environments of Public Financial Management System in Korea. December 2015. Nowook Park, Jong-Hak Weon, Youngmin Oh, Heewoo Kang.

(4) Assessing the Operational Environments of Public Financial Management System in Korea. 4. I. Introduction ················································································································· 9 II. Analysis and Methodology ···················································································· 15 1. Purpose of the Analysis and the Main Content ···································· 15 2. Research Method ······························································································ 17 III. Financial Management's Main Purpose and Methods and Current Trend ·········································································································· 19 IV. Analysis of Korea's Financial Management System ································· 24 1. Mid-2000s Financial Management System Reform ······························· 24 2. Diagnosis of Individual Financial Management Systems ···················· 26 A. National Financial Management Plan ····························································· 26 B. Performance-based System ·············································································· 29 C. Total Budget Allocation Autonomy System (Top-down) ····························· 40 D. Digital Budget Accounting System (dBrain) ·················································· 43 E. Program Budget System ·················································································· 45 F. Accrual-based Government Accounting ··························································· 50. V. Diagnosis of Financial Management System Operation Condition ······· 55 1. Capacity of System Operating Personnel ··············································· 57.

(5) Contents. 5 Assessing the Operational Environments of Public Financial Management System in Korea. 2. Appropriateness of Incentives to Personnel ·········································· 64 3. Communication and Cooperation between Administration and the the National Assembly ················································································· 66 4. Leadership of Head of Institution ···························································· 68 A. Role of a Leader ···························································································· 68. 5. Project Characteristics ··················································································· 72 VI. Conclusion and Policy Implications ································································· 78 Bibliography ····················································································································· 82.

(6) Assessing the Operational Environments of Public Financial Management System in Korea. 6. <Table IV-1> Financial Performance Management System History ···························· 31 <Table IV-2> Common Checklist (2005) ····································································· 35 <Table IV-3> Common Checklist (2015) ····································································· 36 <Table IV-4> Budget Category System Change ·························································· 47 <Table V-1>. Existing Analysis on Leader's Role in Performance Information Usage l ··································································································· 69. <Table V-2>. Performance-oriented Budget System and Suitability across Policy. <Table V-3>. Preceding Studies on Fiscal Performance Differences across Project. Projects ··································································································· 73 Types ······································································································ 74.

(7) Contents. 7. [Figure I-1]. National Competitiveness Index Score Trend on Financial Efficiency ····· 12. [Figure I-2]. National Competitiveness Index Rank Trend on Financial Efficiency ······ 12. [Figure IV-1]. Basic Structure of Financial Performance Management System ·········· 32. [Figure IV-2]. Digital Budget Accounting System (dBrain) Composition ················· 44. [Figure IV-3]. Program and Unit Project Setup Method ············································· 48. [Figure IV-4]. Interplay Between Current Program Budget System and Performance Management System ·············································································· 49. [Figure V-1]. Financial Management Condition ························································ 56. [Figure V-2]. Financial Management Personnel ··························································· 57. [Figure V-3]. Financial Management Capacity ···························································· 58.

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(9) Ⅰ Introduction. This study analyzes the operational environments of various types of financial management systems and discusses ways of improving them. There is no concrete definition of a financial management system. However, it normally refers to a system that pertains to a government’s budget planning, acceptance, implementation, and evaluation cycle. Since the world financial crisis in the late 2000s, public interest in financial management systems has been increasing. Fundamental questions are being asked about expanding financial management coverage and the trustworthiness of finance-related information, because the crisis in the financial sector has affected the treasury as well. Financial risk in the private sector, which was previously overlooked, now has to be considered in terms of its effect on the national treasury, and has cast doubt on the credibility of existing treasury status reports. Recently, the concept of financial management has moved away from its previous narrow definition of government budget management to a broader notion that includes all aspects of public resources management. Following the Asian foreign exchange crisis in the late 1990s, Korea began to reform its financial management system in the mid-2000s. This reform focused on mid- to long-term development, strengthening totalitarian financial regulation, and improving each department's autonomy and responsibility. In short, the reform was conducted in a comprehensive manner through the following changes: the introduction of a mid-term perspective on the budget planning process by establishing a national financial management plan; a downward autonomous budget planning system that strengthened each division's.

(10) Assessing the Operational Environments of Public Financial Management System in Korea. 10 collective regulation and autonomy; performance-focused financial management through a financial performance management system; the introduction of a program budget structure and an accrual-based accounting system; and the establishment of an integrated financial information management system (digital budget account system). Ten years after the reform began, we need to assess the operating status of the system itself, but we also need to assess whether the system is running in harmony with the operating environment. The World Economic Forum (WEF) annually releases a myriad of indices on national competitiveness. In terms of financial management systems, Korea's capacity compares favorably with other countries' collective indices, such as treasury deficits and government liabilities. However, even though these collective indices reflect well on Korea, the absolute levels are decreasing with the aging population, slowing economic growth, and increasing expenditure on social welfare. Therefore, we cannot be satisfied with the statistics that show an internationally stable level. Many pension systems are not mature yet, the effect of the aging population is yet to be seen, and variables such as reunification mean that it is possible for things to deteriorate without notice. In this regard, we need to take preemptive steps to prepare the collective financial risk management system. At the same time, evaluations of micro financial management factors are substandard. Here, we use three of the criteria in the WEF national competitiveness index that pertain to micro financial management: financial source distribution efficiency, project and service delivery efficiency, and treasury expenditure transparency and responsibility. The most comprehensive category includes government efficiency. The WEF national competitiveness index calculates government efficiency as the average of the efficiency of government expenditure soundness, government regulation pressure, the legal framework for conflict resolution, and the result of a survey on government policy operation transparency. With regard to government expenditure, we first examine the results of the survey on the appropriation of public finance and government expenditure soundness. [Figure I-1] depicts the changes in the absolute value of the three criteria for the period 2005–2014. [Figure I-2] shows Korea's ranking among 140 countries in the 2015 report. Interestingly, in all aspects, including government efficiency, government.

(11) Introduction. 11 expenditure soundness, and the appropriation of public finance, the figures began dropping in 2006, becoming steeper after the WEF's 2009 report. This report assessed 2008, which coincides with the change in Korea’s government. A dramatic revamp of financial management systems took place between 2003 and 2007. When the new government took office in 2008, it did not discard the financial management system operation framework. However, there were changes that reversed the framework progress on budget authorities and respective divisions with regard to financial management systems. For instance, in the process of integrating the Ministry of Finance and Economy and the Ministry of Planning and Budget, the division of labor and cooperation among organizations operating financial management systems and budget planning organizations weakened significantly, and the structural reorganization strengthened the traditional budget planning body's characteristics. Figures indicating the international ranking and the absolute scores on government expenditure soundness, appropriation of public finance, and government efficiency began decreasing when the abovementioned changes occurred. However, this trend then changed again in 2013. It is also interesting to note that this time point coincided with the start of the new government in 2013. The new government that took power in 2013 emphasized evaluation and feedback for financial business operations, and also discussed the importance of preventing treasury leakages. The WEF reports are based on surveys of foreign companies within Korea on the question of government expenditure soundness and the appropriation of public finance, which suggests that the government's efforts may have contributed to the improvement in the previous worsening trend. However, it remains difficult to return to the 2006 and 2007 levels. The reason for this is not easy to identify. However, we can assume the government tried only linear reforms after 2008, while failing to come up with fundamental methods to rework financial management efficiency. In other words, there was no fundamental prescription for the financial management systems introduced in the mid-2000s, which suffered from weak effectiveness. This study starts from the position that the government failed to invest adequately in an environment necessary for policy effectiveness, and that most of the issues surrounding the worsening government expenditure efficiency and transparency have their roots in the ailing financial management system..

(12) Assessing the Operational Environments of Public Financial Management System in Korea. 12. [Figure I-1] National Competitiveness Index Score Trend on Financial Efficiency. score Waste of Government Expenditure Misuse of publice resources Government Efficiency. Source: Author edited WEF Database (reports.weforum.org/global-competitiveness-report-2015-2016, accessed October 2, 2015, downloaded in GCI Dataset in Microsoft Excel). [Figure I-2] National Competitiveness Index Rank Trend on Financial Efficiency. ranking Waste of Government Expenditure Misuse of publice resources Government Efficiency. Source: Author edited WEF Database (reports.weforum.org/global-competitiveness-report-2015-2016, accessed October 2, 2015, downloaded in GCI Dataset in Microsoft Excel).

(13) Introduction. 13 There have been analyses on whether the policy is able to create the effect it was designed to have. However, creating an environment to properly implement the policy has received less attention. If the policy is not being run effectively, one of the causes may be the absence of a proper environment within which to operate the policy. This study analyzes such an operating environment for the existing financial reforms, and discusses ways in which it can be improved upon.1) Many empirical studies have shown that the performance of private companies is influenced significantly by their management system. Bloom et al. (2014) provide evidence that a quarter of a company's productivity difference may arise from management factors. If the private sector's management system is this important, it is highly likely that the government's productivity or effectiveness will experience an even greater influence from these factors.2) Private companies, which operate under market rules, have an incentive to establish an effective management system as a means to improve productivity. In contrast, the market rules for governments are not as strong as those that apply to private companies. Instead, they are influenced more by elections, which tend to be less effective than the market, leading to few incentives to produce an effective management system. In particular, the election culture and system tends not to have a mid- to long-term perspective, making it difficult to establish and operate a management system that requires investment over such a time frame. This study starts from the question and premise that a management system may have greater significance in the public sector than it does in the private sector. Furthermore, effective reforms of public finance and government expenditure productivity need a management system that operates effectively within the government. The major purpose of this study is to assess environments. 1) Some may see the situation from the opposite point of view, in other words, that we ought to develop a financial management system that suits the operation environment. However, when we follow the principles, we first have to design a system that will most effectively achieve the goal. Then, matters pertaining to the operating environment need to be improved continuously thereafter. 2) This trend has resulted in increased numbers of empirical analyses of factors affecting developing nations' public sector management..

(14) Assessing the Operational Environments of Public Financial Management System in Korea. 14 in which to operate the previously introduced financial management system effectively in terms of the planning, budget allocation, project management, implementation, monitoring, and feedback of the government's financial projects, as well as ways in which these can be improved. First, we introduce the main purpose and tools of a financial management system, and then we analyze Korea's system and its operating environment. Lastly, we examine the policy implications of our results, and suggest possible ways forward..

(15) Ⅱ Analysis and Methodology. 1. Purpose of the Analysis and the Main Content. Externally, Korea operates a public financial management system3) that has introduced a myriad of modern systems, and empirical analyses have examined the effectiveness of the system and its effects on personnel behaviors. However, there have been few studies on the operating environment and how it limits the financial management system. This study intends to analyze this operating environment. When Korea's financial management system is considered at a system level, it is praised as an outstanding example.4) However, we now need to assess the system's effectiveness and whether it has any unintended side effects. For example, increasing concern over the system’s financial sustainability has raised doubts about how well it is functioning in terms of collective financial regulation, one of the crucial purposes of a financial management system. Despite having a mid-term perspective on budget planning through an annual national financial operation plan, there remain questions on how it is utilized within budget. 3) Public financial management has no clear-cut definition; however, it refers to systems relating to budget allocation, authorization, and execution. The goal of public financial management is attaining budget sustainability, the effective allocation of finance, and efficient delivery of service. As the term itself suggests, it is not a passive administrative concept; it would thus be more appropriate to call it a “financial management system”in Korean. 4) Fiscal rules, mid-term budget, and long-term fiscal outlooks for collective fiscal regulation have not yet been properly introduced or are not being used to the fullest..

(16) Assessing the Operational Environments of Public Financial Management System in Korea. 16 planning. Even though they have tried to plan budgets in a way that upholds the collective rules, while maintaining autonomy and professionalism, by adopting a downward autonomous budget planning system, there is skepticism on whether each department's autonomy in budget planning has actually improved. The financial performance management system that was adopted to continuously reform the expenditure structure is being questioned in terms of its real influence on the reforms. There are also doubts over how well the digital budget accounting system has been used in the decision-making process, despite its having improved the interconnectedness of information. In addition, the effectiveness of an accrual-based accounting system is being questioned. Along with the system's performance, limitations in its effectiveness are starting to be attributed to the operating environment. In order for the current financial management system to be run properly, we need continuous improvements in the operating environment. However, people tend not to pay attention to or invest in environmental improvements. These types of operating environment improvements often require fundamental changes in the operation of the government, leading to many cases where the system framework is adopted, but the surrounding basis does not change to suit the new system. If a system and its surroundings do not work together, the new system will not run effectively and the change will be nominal only, further incurring new costs and unexpected side effects. For example, a new financial management system necessitates professionalism and a capacity for budget planning authorities, project departments, and even the National Assembly and the Board of Audit and Inspection of Korea. However, whether these organizations are acquiring the necessary qualities is still doubtful. If related organizations are not able to acquire the required capacities, the information provided by the system will fail to satisfy quality levels, with the result that we will not be able to apply the information in decision-making processes. Thus, despite the presence of a new system, the decision-making process may be no different. Korea modeled its mid-2000s financial management system reform after an internationally accepted system, and there were attempts to improve the system's operating environment. For instance, the Ministry of Planning and Budget, the financial management system's operating entity at the time, went through structural reform, despite opposition from both inside and outside..

(17) Analysis and Methodology. 17 Furthermore, the department strengthened areas such as budget planning and evaluation functions, albeit in a limited way. However, the government's endeavors did not last long, and even reversed after a while. What we have dealt with in the introduction reflects the situation well. In addition, there are doubts about the effectiveness of individual financial management systems. This study has as its purpose deriving the best operating environment and an improved alternative by assessing each of the relevant facets. Components included in financial management systems are the production of new information, changes in the financial management process, and an indication of decision-making rules pertaining to financial management. The system processes include budget planning, budget implementation and project management, project monitoring and evaluation, and project result feedback. The definition of a financial management system is expanding from its traditional meaning. Such systems now include managing financial risk, introducing a mid- to long-term perspective, and managing the performances of financial projects.. 2. Research Method. This research examines the financial management system by delving into the status quo and limitations of Korea's system, as well as international trends. The changing trends in financial management systems after the world financial crisis are the expansion of financial management and changes in emphasis. Owing to the fact that the financial crisis precipitated a treasury crisis as well, the importance of contingency liability5) for financial management has become apparent, along with doubts about the treasury statistics. In other words, the significance of financial risk management has become increasingly important. Even though Korea's financial risk management system is operating tacitly, it is very much unofficial in essence, making it difficult for us to tell whether. 5) In Korean, we translate this as“contingency liabilities,”but this definition seems too narrow in terms of the original meaning. Thus, we define it as“conditional liabilities”because it works as a liability only under certain conditions..

(18) Assessing the Operational Environments of Public Financial Management System in Korea. 18 there is a well-established system. On the other hand, existing systems are being utilized in very limited forms. The main purposes of the financial management system, namely the sustainability of the treasury, finance source distribution rationale assessment, and efficiency of service delivery, will be the focus of our analysis of the current system. In order to analyze the financial management system's operating environment, we first extract the crucial factors in operating the system, and then we analyze the individual environments based on the filtered data. For the main operational environment factors, we discuss personnel capacity and issues with incentives. Furthermore, we examine the relations with the National Assembly, leadership issues from an organizational perspective, and the need for differentiated financial management based on individual project characteristics. It is no easy task to analyze the appropriateness of an operating environment using empirical evidence, because there are facets that appear externally, as well as formless factors that pertain to an organization's internal culture. Factors that are easily observable from outside, including organization reform, development of a new education program, division of labor among related agencies, continuity of work on certain projects, and reinforcement of human resources, can be evaluated through historical records or current statistics. For qualitative factors, such as leadership, organizational culture, and personnel incentives, we can utilize surveys or expert evaluations. However, we prioritize using objective situational factors and refer to existing surveys or expert evaluations when available..

(19) Ⅲ Financial Management's Main Purpose and Methods and Current Trend. Public financial management's main purpose is to acquire substantiality, allocative efficiency, and technical efficiency. Economy activation and stabilization may be added as a financial purpose from a macro perspective; however, as far as financial management is concerned, financial substantiality bears greater importance. The main goals of financial management are to maintain substantiality, achieve allocative efficiency exercised to maximize policy effectiveness, and achieve technical efficiency by using the minimum costs possible. In order to achieve the abovementioned three purposes, a few tools are available: development and sharing of required information; improvement of work processes and decision-making processes, and the adoption of written rules. It would be most appropriate if the decision-making and financial management purpose could be achieved solely by developing and sharing the required information. This is because the information can then be used by decision-makers for better results, reducing the potential costs arising from establishing rules or regulations and decreasing unexpected side effects. Of course, when such information is produced and released, we need to put in place the necessary incentives for the decision-makers to utilize the information. The second phase is the improvement of the work processes and decision-making intended to revamp the effectiveness by bringing in changes to the management work process. For example, instead of operating an upward process where departments write up and request budget needs for planned.

(20) Assessing the Operational Environments of Public Financial Management System in Korea. 20 projects from authorities, we can think of a downward approach where the budget authority confirms total budget plans and departmental plans within the budget cap provided. If rational decision-making can occur through these series of changes upon work and decision-making processes, this might be better than using written regulations. Written decision-making rules, when imperfect, lead to side effects. In the last phase, when the problem fails to be solved solely through information sharing, changes in work and decision-making processes and explicit rules that compel decision-making can be introduced. Written rules are limited in the fields requiring flexibility and, therefore, require thorough consideration. Recent international efforts to acquire substantiality, allocative efficiency, and technical efficiency include the following: mid- to long-term time series; expansion of financial range; risk management methods; non-financial performance information development and usage; creation of accrual-based information; and apt division of financial management work. In order to introduce the mid- to long-term time series, they are making mid-term financial management plans and reports on the long-term financial outlook. By establishing mid-term financial management plans, we can recognize a three-to-five-year range of financial necessities in advance, which are attempts to overcome short-sighted one-year budget planning. In addition, as welfare expenditure, such as pension and public medical expenditure, grow rapidly with the aging population, there also are attempts to foresee a minimum of a 30-year time series in order to attain financial substantiality. With the recent treasury crisis, which had its roots in the international financial crisis, people are also making active efforts to interpret finance's range more broadly when creating related information. In addition to expanding the ruling entity's range, they are trying to expand the type of transactions that may lead to financial risks. Including the private sector's risk, threats to financial substantiality are diversifying, making it imperative for us to adopt financial risk management methods. There are also endeavors to strengthen the responsibility of financial expenditure and the effectiveness of the budget distribution through the creation and utilization of non-financial performance information. It is reported that, at least nominally, almost every OECD country uses a financial performance.

(21) Financial Management's Main Purpose and Methods and Current Trend. 21 management system. Shifts to accrual-based accounting information are being used to upgrade financial information's reliability and, in terms of financial management system operation, decentralization is being used to imbue the individual units with appropriate levels of autonomy and responsibility. These various international trends can be summarized as follows: the creation and utilization of financial management information; a revamp of the responsibility and autonomy of financial projects' actors; and the expansion of the boundaries of financial risk. There is an urgent need for us to reflect on the effectiveness of financial management systems in the post-financial crisis of the late 2000s. There are two aspects that we can consider: first, whether the role of the system was appropriate in the process of overcoming the financial crisis, and second, whether the system contributed to financial management soundness before the financial crisis. During the financial crisis, in order to avoid an economic depression, the government implemented treasury expenditure intended to boost the economy. However, this needs an evaluation of the role the financial management system played. It was not only the relief projects they worked on. They also made massive expenditures for an economic boost. Furthermore, this facet requires that we check on the role of the financial management system and assess whether they took the right follow-up actions after these temporary expenditures. The crucial point in economic boost expenditure is whether the money spent was used in areas that needed it. Furthermore, appropriation structure reform for financial soundness recovery has to involve reform based on performance, and not simply budget cuts. We have no established evaluation on this. However, experts say that the role of a financial management system changes depending on the time required to alter the expenditure size and the scale of the expenditure. When this needs to happen in the short term, utilizing the existing system's performance records for appropriation restructuring is not suitable. On the other hand, when there is sufficient time, nations can involve the performance information in the process. This is paradoxical in that, in a situation where the performance information should benefit us the most, it plays a very small role. The second section, namely the role of the financial management system.

(22) Assessing the Operational Environments of Public Financial Management System in Korea. 22 prior to the financial crisis, is also not well documented. If the system was run well during good times, they might be able to tackle the crisis with more ease. However, this was not the case. G7 countries' public sector liability in comparison to GDP was at 35% in 1974, which grew to 80% in 2007, just before the financial crisis. Even if we disregard the treasury expansion that started during the financial crisis, during normal times, there should have been a surplus of finance reserves. However, in reality, the treasury deficit was accumulating even then. In addition, information on the government deficit scale was not accurate, and they were not aware of the possible repercussions of a financial crisis on the treasury. Along with the developed nations’ reflection on financial management systems, developing nations are also mulling over this topic. Financial management systems were widely introduced into developing nations as a condition to reform the governance. In order to assess the effectiveness of these systems, the World Bank's IEG produced critical evaluation reports. As a reaction to this, the World Bank's project department created mid-term budget system evaluation reports that contained empirical data on performances. Adding to this discussion are the issues arising from the adoption and operation of financial management systems. Currently, studies are examining how developing nations are strengthening the professionalism among accounting-related occupations. Korea made preemptive actions on its financial management system in the late 1990s after the Asian foreign exchange crisis. In particular, the mid-2000 reforms were done in a comprehensive manner, modeled after modern systems. The national financial operation plan, top-down autonomous budget plan, financial performance management system, program budget structure, integrated financial information system, and accrual-based accounting were some of the things implemented. Despite such a comprehensive system, financial risk management and appropriation restructuring were dealt with weakly. This may be because the mid-2000s was a time of overcoming the economic crisis and the treasury was recovering as well. Owing to this, even though it was a preemptive plan, there were no designs to take financial risk management into consideration. For instance, there are virtually no fiscal rules, and long-term financial expectations are not announced officially. Furthermore, the financial performance management system is not able to create strategically meaningful.

(23) Financial Management's Main Purpose and Methods and Current Trend. 23 levels of cost reduction, and there is no genuinely independent fiscal institution. Together with the insufficient financial management system is the lack of investment to improve the operating environment. Insufficient thought was given to the effectiveness and reforms necessary for the financial management system after the change in government that lead the revamp. This study, based on these problems, discusses the operating environments and the need to revamp them..

(24) Ⅳ Analysis of Korea's Financial Management System. 1. Mid-2000s Financial Management System Reform. President Roh's government, which took in power in 2003, reformed the fiscal operation principles to adapt to the changing fiscal environments in 2005. The main things to take note of are the long-term fiscal operation plan, top-down total budget appropriation system, performance management system, and digital budget accounting system, which are the four fiscal reforms, and lastly, the codification of National Fiscal Law. The Roh government's four fiscal reforms are innovative in that they revamped the previous fiscal operation method and established them in terms of content and structure. The following are the reasons why the four fiscal reforms are of high quality. First, procuring fiscal substantiality requires a long-term perspective that can allocate the fiscal expenditure needs at times of fiscal expansion. The four fiscal reform's long-term financial operation plan is a system to derive the future five-year long fiscal need predictions. Fiscal predictions predict the government's future fiscal outlook on a long-term basis, which includes sectors such as the social welfare, labor, education, and national defense. When sector by sector expenditure aggregates are decided through a long-term financial outlook, then the budget is allocated to each department. As the total expenditure is decided through fiscal outlook, the amount that each department receives will be automatically decided by how much of a project.

(25) Analysis of Korea's Financial Management System. 25 a department holds. Therefore, in order for the long-term fiscal outlook-based expenditure cap to operate well, we need to shift away from a bottom-up approach, where the respective departments submit the required budgets to the budget authorities in a top-down approach. Here, the budget authority decides the aggregate first, and then divides it up among the individual departments. When the budget is handed over to a department, they allocate it based upon the project needs. Problems arise when the budget is set by the fiscal outlook and the actual needs of the department. So what happens when a department's request is larger than the amount determined through the fiscal outlook? Within the four fiscal reform plans, they have included a performance management system as part of their fiscal reform so as to make the department evaluate its projects to assign the allocated budget with the respective priorities out of its evaluation. In other words, it is a system where the department itself decides to either expand, maintain, reduce, or even halt a project based on the results of each project. Long-term financial plans, net appropriation top-down budget plans, and performance management are necessary components that must work organically under the same goal of acquiring fiscal substantiality. In addition, to determine the meaning of fiscal substantiality, we needed to acknowledge the government's income and liabilities the moment they are incurred, which leads us to adopt an accrual-based accounting system. Furthermore, they need a unit to centrally plan the budgets under the same purpose categories, which leads to the introduction of a program budget system simultaneously. As was evident, the Roh government's fiscal reform was systematic and logically well established. Lastly, in order for the accrual basis, program budget, performance management, and budget planning to function organically, they should be made accessible through a single tool. That is why the digital budget accounting system was introduced to form the cornerstone for the long-term fiscal plan, total budget allocation autonomy system (top-down), and performance management. How should we introduce a financial management system with this degree of perfection? Do we have to set up the base platform, namely the digital accounting system, accrual-based accounting, and program budget structure, and then move on to a long-term financial outlook or total budget allocation autonomy system (top-down) and performance management? Or, since the long-term.

(26) Assessing the Operational Environments of Public Financial Management System in Korea. 26 financial outlook is the core of financial substantiality, do we have to introduce this first and then move on to an autonomous total budget allocation autonomy system (top-down) and performance management? Alternatively, should the budget system that people have become used to be reformed slowly while a performance-based system and digital accounting system, which may have relatively less resistance, be introduced first? When it comes to the introducing the system, we have the so-called big bang approach, where everything is changed all at once. The other method is to make adjustments in stages. A strength of a step-by-step approach is that it facilitates the introduction of a system because it reflects reality as it is assimilated. However, the downside is that, depending on which part of the system is introduced first, the latter can receive unexpected influences, leading to potential diverted usage. The big bang approach adopts a system at once. The merit of this method is that we can maintain the intended purpose of all systems. However, because the whole system has to be revamped at once, the system may be difficult to implement. Considering the pros and cons of the two methods, the big bang approach may be more appropriate. The Roh government's financial reform displays a significant difference from previous series of reforms, and even though the content is independent, they are organically interconnected and designed to be effective when they work together. Therefore, the big bang method seems more suitable, and indeed, the reform took this format. However, there are criticisms that the Roh government failed to reflect reality sufficiently, chasing after ideals. Henceforth, we examine Korea's individual financial systems' purpose, operation status, and suggestions.. 2. Diagnosis of Individual Financial Management Systems. A. National Financial Management Plan Environments surrounding finance are changing rapidly because of the aging population and globalization, adding to the importance of finance's role..

(27) Analysis of Korea's Financial Management System. 27 However, finance usage before 2005 maintained the traditional method where the budget authorities would assess individual projects to plan the budget. Limitations of macro analyses and financing allocations based on national priorities were noticed, and irrational customs in the budget planning stage, such as excessive demand and information distortion, were rampant. In addition, it was difficult to utilize each division's profession. Thus, it was a difficult structure to adapt to changing environments.6) In this situation, based on the goal of adopting a strategic resource allocation system, there is a need to establish a five-year national financial management plan that can pursue macro and strategic finance allocations. The policy changed the finance operation principles, where we can set the expenditure limit and individual departments can then plan their budgets based on their experience in the field.7) After the National Finance Law defined the financial management system, including the national financial operation plan, and was codified in 2006, the four fiscal reforms were able to build on the momentum. Details pertaining to national financial operation are indicated in the National Financial Law Article 7:8) the national financial operation plan has to be written every five years and should be submitted to the National Assembly 120 days prior to the new accounting year. The plan must include its basic direction and objectives, midto long-term financial outlook, sectoral finance allocation plan and direction, finance scale increment rate, and rationale. What was initially 16 sectors was downsized to the following 12 sectors:9). 6) The background and ongoing process of mid-term finance is referenced in Bae and Kook-hwan (2007, pp. 19–20). 7) The first time a mid-term fiscal operation plan was written in Korea was 1982, during the fifth economic development plan. However, this was done to quench the chronic fiscal deficit and to manage and operate mid-term finance at that time (Na, Ajeong, Park, Seung-joon, 2009, p. 3). Thus, the name may be the same, but they are substantially different. 8) ｢National Public Finance Law｣'s original text can be found at http://www.law.go.kr/lsInfoP.do?lsiSeq= 166528&e fYd=20150701#0000 (accessed August 20, 2015). 9) 2014–2018 National Fiscal Operation Plan can be accessed at http://www.mosf.go.kr/policy/policy02. jsp?boardType=general&hdnBulletRunno=76&sub_category=127&hdnFlag=1&hdnDiv=182&&actionType= view&runno=4093238 (accessed November 14, 2015)..

(28) Assessing the Operational Environments of Public Financial Management System in Korea. 28 1) medical, welfare, and employment; 2) education; 3) culture, sports, and tourism; 4) research and development; 5) small and medium-sized companies and energy; 6) social overhead capital; 7) agriculture, fishery, and food; 8) environment; 9) national defense; 10) foreign affairs and reunification; 11) public order and security; 12) normal and rural governance. By forming a national financial operation plan at a minimum of five years, they were able to escape the annual short-sighted perspective, and the system could change to accommodate the mid- to long-term perspective. As such, the finance allocation can now reflect the national policy priorities better. For instance, by reducing the expenditure where the market can cope on its own, they were able to expand expenditure on the welfare and life quality sector, which is one of the government's inherent traits. With the regularly written national finance operation plan, direction was able to be provided on macro-economic factors such as the fiscal status, national liabilities, and national burden, which allowed room for systematic reaction to potential fiscal risks. In addition, the finance authorities' strategic perspective and each department could jointly allocate resources strategically and effectively, while increased departmental budget planning authorities improved the cycle of "abusive demand to huge cut." However, there are some doubts over the effectiveness of the national finance operation plan. First, even though the plan is submitted to the National Assembly along with the budget layout, it does not go through a deliberation process, unlike the budget layout. In addition, because it does not have binding power, the executive body is not restricted in terms of planning and operation.10) In other words, because it does not have any restrictions on the plan, if there are no tangible means to ensure the effectiveness, the newly introduced system does not make much difference, except for the fact that it only creates plans annually.11) However, even though the national finance operation plan is not legally binding, it is still a document submitted to the National Assembly together with the budget layout. In addition, because it is open to the public, it should be. 10) Na, Ajeong, Park, Seung-joon (2009, p. 5). 11) Na, Ajeong, Park, Seung-joon (2009, p. 5)..

(29) Analysis of Korea's Financial Management System. 29 taken as a sign that the government has expressed its official intention on finance allocation. Furthermore, we take great care when trying to give the plan observation a legal power, because, as was explained above, one of the functions of the treasury is economic stabilization. To stabilize the economy, the government has to work flexibly, depending on the economic situation. However, if the national finance operation plan binds the government, this function of the nation will not be able to operate. The treasury's role in stabilizing life and adjusting to the ever-changing international environment is growing, and in this situation, the role of the national finance operation plan that, at the center of all financial activities, provides the basic direction of finance operations is crucial. However, as the plan contains predictions, we cannot necessarily synchronize the actual results.12) Owing to the unpredictable nature of the future, the national finance management plan cannot possibly be legally binding. Of course, improving the accuracy of predictions is crucial, and needs continuous efforts. However, more important than this is the direction that the plan suggests, for example, how national finance will operate against external changes. It is only through predictions based on the understanding and analysis of the changing economic and social environment that we can formulate the basic direction for the economy and society, and resources have to be allocated accordingly. B. Performance-based System13) With the 2005 financial reform, the performance management system was applied in all departments, but the performance concept itself started from. 12) According to the Korean Association of Public Finance (2013, p. 2) analysis of a decade-long national fiscal operation plan and actual figures between 2004 and 2013, the five-year economic growth estimate was 4.6%, while the actual figure was 3.1% (a 1.5% difference). The biggest gap was 3.3%, while the minimum was 1.3%. The national liabilities five-year estimate was 410.7 billion won, while the actual figure was 419.6 billion won (a 8.9 billion won difference). The biggest gap was 20 billion, while the minimum was 3.5 billion won. Even though economic growth was pegged at more than 1.5%, optimistically, considering the unexpected 2008 financial crisis and Southern European crisis, it should not be a big difference, and the national liabilities prediction showed only 2% of the total scale. 13) See Park et al. (2008) and Park, Noh-wook, Won, and Jong-hak (2009, 2012)..

(30) Assessing the Operational Environments of Public Financial Management System in Korea. 30 2003, where they intended to assess project and budget expenditure effectiveness.14) <Table IV-1> summarizes the main changes made to Korea's financial performance management system after its introduction in 2003. There are three reasons why the performance system was introduced to the government sector: efficiency improvement on budget expenditure, project effectiveness , and project responsibility. In order to achieve the above-mentioned objectives, the starting point for finance project performance management must be the production and evaluation of performance information: in other words, which method and what kind of performance information will be produced to evaluate the finance project's performance.15) There are three main methods in assessing a finance project's performance: monitoring performance based on a performance index and goals, reviewing format performance measurement that utilizes existing information on project performance, and the project assessment method that analyzes data to scientifically approach the finance project's effectiveness. In Korea, these three types are run under the names of "financial performance and objective management system," "financial project selfvaluation," and "financial project in-depth evaluation." We can draw some analogy from medical check-ups to understand the three basic structures of financial performance management. Monitoring performance objective management is similar to temperature and BMI checks, which can be checked in everyday life. The review format assessment is more like a regular check-up that happens in a hospital. The latter is not a simple index that uses a monitoring method, but is conducted using a systematic check-up list that the government has on each project to assess efficiency and effectiveness.. 14) Fiscal reform was conducted using the big bang method in 2005, and preparations were put in place beforehand. The performance management system was no exception. See Park, Noh-wook, Won, and Jong-hak (2008, pp. 13–14). 15) A fundamental question about performance evaluation is whether the fiscal project performance can be measured. Here, we can debate whether measuring the degree to which a budget project influenced the goal, and whether the project's goal is clear. However, this is beyond the scope of this study..

(31) Analysis of Korea's Financial Management System. 31. <Table IV-1> Financial Performance Management System History Year. Main Changes 1). ’03. ∙ Introduction of performance management system. ’05. ∙ First self-financial project evaluation executed. ’06. ∙ In-depth financial project evaluation executed. ’07. ∙ Integration of performance plan and performance management plan. ’08. ∙ First submission of national performance plan as an attached document to budget layout to the National Assembly in 2009. ’09. ∙ Separation of performance plan and performance management plan. ’10. ∙ First submission of 2009 government performance report as a part of accounting report ∙ Synchronization of performance management system and program budget system ∙ Expansion of in-depth evaluation targets to project basis. ’11. ∙ Mandating the performance plan's project content and costs to synchronize with the budget layout start from 2011 accounting year. ’13. ∙ Overall summary and analysis of government performance plan and performance report from 2014 performance plan. ’14. ∙ Starting from 2015 performance plan, performance management system (performance target-managing tasks) was established by synchronizing with budget, fund program, and projects ∙ Starting from 2015 performance plan, project-related tax payments were recorded together ∙ Trial of PI Board * Situation board that monitors and manages the performance level in individual departments in project units. ’15. ∙ Self-evaluation reform: from project basis check-up to meta-evaluation method. Note: 1) Performance management here refers to a part of the financial management process where finance projects are managed based on evaluation results from an index derived from major finance projects (budget + fund) objectives, and a performance index preset before evaluation. Sources: 1. National Assembly Budget Office, ｢2015 Government Performance Plan Evaluation(Total and Departments)｣, 2014. p. 26. 2. Gong, Dong-sung, 󰡔Performance Management – Korea's Policy󰡕, Dae-young Books, 2013. 3. Korea Institute of Public Finance, 󰡔Public Finance Forum󰡕, ｢Public Finance Project Evaluation System's Operation Performance and Suggestion on the System｣, 2014.12. 4. Ministry of Strategy and Finance, ｢2015 Finance Project Self-evaluation Guideline｣ 5. Ministry of Strategy and Finance, ｢2014 Performance Plan Guideline｣ 6. Ministry of Strategy and Finance, ｢2015 Performance Plan Guideline｣ 7. Ministry of Strategy and Finance, ｢PI Board Trial Guideline｣. 2014. 3..

(32) Assessing the Operational Environments of Public Financial Management System in Korea. 32 In addition, through regular check-ups, we learn which part of our body sends abnormal signs using high-end equipment such as CT scans and MRIs, and the process we use for the in-depth evaluation takes a similar route. In an in-depth evaluation, when projects are identified as having problems through performance objective controls or financial project self-evaluations, they are analyzed scientifically to determine the cause of the problems and what tools are appropriate to solve them. As seen until now, each stage's result is being used as the beginning point for the following stage, just like during a medical check-up, and each stage's result is used as feedback and as basic reference data for performance management. [Figure IV-1] depicts this process.. [Figure IV-1] Basic Structure of Financial Performance Management System. Source: Park, No-eul and Won, Jong-hak (2009), redrawn based on Figure on p. 31. 1) Financial Performance Objective Management System Korea has a “financial performance objective management system” that measures performance based on a performance index and targets a monitoring performance management method. Each department has to submit an annual “performance plan” and “performance report” to the National Assembly that covers annual financial plans and objectives and the causes and effects of the.

(33) Analysis of Korea's Financial Management System. 33 performance achievement level. The pros of this method are that we are able to see first-hand the performance achievement status and problems by examining the government's policy and budget projects systematically. Owing to this advantage, many countries take the monitoring method approach to create and use performance information.16) If a financial project's performance management system is being used as a basic performance information creation method, we can utilize this type of monitoring information. Korea has run pilot programs on some of the government departments from 2000 through 2002 and, in the process, have created performance plans and reports. From 2003, only a few departments wrote up the performance plan, and in 2006, the practice spread to all departments. Similarly, the performance plan application took several steps from 2003, and in 2010 became mandatory. However, in reality, the budget authorities fail to actively use the two documents. Why has the performance index and target-focused performance information failed to be used by the budget authorities until now? One possible reason could be the limitation of the information that is derived from the objective management system method. As explained earlier, the performance index and target are only signals, so their information provides general trends only. If a performance index could reflect project performance, it could be used during the decision-making process, but typically, performance plans and reports only serve as the starting points for additional information. Therefore, in order to use monitoring information in decision-making processes, it requires evaluator professionalism, project manager's capacity, and well-organized communication with the decision-maker. The project manager must grasp the project well and the evaluator and decision-maker must, along with understanding the project, have the capacity to analyze and gather information based on well-established communication.. 16) A typical example is the US Government Performance and Results Act (GPRA), which was implemented in 1993 and expanded in 2010 as the Government Performance and Results Modernization Act (GPRMA)..

(34) Assessing the Operational Environments of Public Financial Management System in Korea. 34 Adding to this limitation of performance information, there is a more fundamental reason why information asymmetry exists between the budget authorities and the project manager. Because the information that the budget personnel knows about a project is different from what the project manager has, when the evaluation result gets reflected to budget planning, the project manager will try to take a defensive position based on limited information. Thus, it is not easy for the budget authorities to use a performance index and target levels during the budget planning process. Thus, the authorities find it difficult to use the information created from the financial performance management system. However, information based on a performance index and target levels may be more useful within an organization itself. The rationale stems from the fact that the information asymmetry issue is less of a problem than it is for outsiders. Thus, information gathered through a performance index and target levels should be more suitable for project within departments than it is for the central government's budget authorities. 2) Financial Project Self-Evaluation Financial project self-evaluation is the review of performance information that Korea creates. The review format is not a creation of new performance information, but is rather a process of systematically gathering and analyzing existing performance information. However, if the existing performance index or target level is not set up and the evaluation is not done regularly, then we have to create the information for the review format. Thus, in some limited cases, we have to create new performance data. The review process involves the budget authorities first setting up the perspective that they believe is important, suggesting the decision criteria, and lastly, demanding that the project department provide the information and evidence. Specific check-up criteria are shown in <Table IV-2> and <Table IV-3>. <Table IV-2> shows the check-up list and scoring system on the first operation in 2005. <Table IV-3> shows the check lists in 2015.17) When the.

(35) Analysis of Korea's Financial Management System. 35 two are compared, there might be some changes after 10 years. However, the main point is almost the same. The past decade was relatively securely maintained. <Table IV-2> Common Checklist (2005) Stage Plan (30) Performance Plan (15). Implementation (20). Criteria. Score. 1-1. Is the project purpose clear?. 5.0. 1-2. Does it unnecessarily overlap with other projects?. 5.0. 1-3. Is the current project operation method efficient and suitable?. 5.0. 2-1. Does the performance index have clear causality with project purpose?. 7.5. 2-2. Is the performance index goal enthusiastic?. 7.5. 3-1. Have finance sources been utilized the way planned?. 5.0. 3-2. Are they improving issues using the monitoring system?. 10.0. 3-3. Was the project evaluation objective and comprehensive?. 5.0. 4-1. Have they reached the goal of the performance index? Usage of Result (50). 4-2. Is the project being operated effectively after the evaluation? 4-3. Have they worked on efficiency in the process of reaching the goal? 4-4. Have they used the assessment result into system improvement and budget planning as feedback?. 30.0 5.0 5.0 10.0. Notes: 1. Ministry of Strategy and Finance provided standard answers to the questionnaire 2. Departments answer either “yes” or “no,”; if they answer “yes,” they must provide evidence 3. Performance satisfaction and customer satisfaction questions are answered as “yes,” “very much,”“little,” or “no.” Source: Ministry of Strategy and Finance, ｢2005 Financial Project Self-evaluation Guideline｣, 2005. 1.. 17) Check-up points were not constant between 2005 and 2015. When an annual evaluation is done, it is reworked, and points and scoring are adjusted..