This paper • proposes an analytical framework and policy instruments to secure fiscal space for financing a national development strategy. central premise: “the sustainability of policies to create fiscal space is a function of w ha t the fiscal space is used for.” • the balance of emphasis placed on the stabilization, allocation and distribution and growth functions of fiscal policy would differ according to the timeframe of the analytical framework political economy context • indicators used to assess fiscal solvency and sustainability different if the assessment is carried out in a long-term or short-term analytical context.
Design of paper Section 1: Analytical framework- Fiscal space diamond Section 2: Country specificity; middle income vs low income countries Section 3: Counter cyclical fiscal policy Section 4: Sustainable scaling up
World bank, IMF: “the ga p betw een the current lev el of exp end iture a nd the m a xim um lev el of exp end itures a g ov ernm ent ca n und erta ke w ithout im p a iring its solv ency ” Peter Heller: “the a v a ila b ility of b ud g eta ry room tha t a llow s a g ov ernm ent to p rov id e resources for a d esired p urp ose w ithout a ny p rejud ice to the susta ina b ility of a g ov ernm ent’s fina ncia l p osition ”
Our definition: “Fisca l sp a ce is the fina ncing tha t is a v a ila b le to g ov ernm ent a s a result of concrete p olicy a ctions for enha ncing resource m ob iliza tion, a nd the reform s necessa ry to secure the ena bling gov erna nce, institutiona l a nd econom ic env ironm ent for these p olicy a ctions to b e effectiv e, for a sp ecified set of d ev elop m ent ob jectiv es.”
World Bank, IMF => Macroeconomic stability equals short term macroeconomic stability…even if long term solvency improves fiscal expansion undesirable Approach ignores positive endogenous effect of additional public investment on solvency and stability E.g. fiscal space for military spending have different impact from investment in rurla loans but standard analytical framework cannot distinguish between the two Recent research=> long run macro stability implications of fiscal expansion significantly different from that revealed in short run analysis (Gupta, Powell, and Yang, 2006; Bruno and Easterly, 1998)
• Impact of public investment on growth => 40 study reviews inconclusive • However, poverty trap and bottleneck theories provide powerful arguments for sp ecific public investments impacting growth • Stronger evidence on positive impact of public investment on human development
Fiscal space diamond 1. Official Development Assistance (% of GDP) 2. Domestic Revenues 4. Reprioritization Mobilization (% of GDP) & Efficiency of Expenditures (% of GDP) 3. Deficit Financing (% of GDP)
Use with care • The diamond is created in cartesian space, it seems to imply that there is a choice between the four instruments of fiscal space. This is not true. • ODA is exogenous. Expenditure switching and pareto efficient public expenditure reforms clubbed together • Country specificity is important. Essential to define precisely • Policy assumptions underlying the diamond • Time frame within which different measures take effect • Whether actions to secure fiscal space are endogenous or exogenous to d om estic policy making Next four slides present example
a- Aid. External budget 1. ODA b- Debt Relief. support subject to Completion point reached volatility and projected a% under the Enhanced HIPC gradual decline in foreign initiative and approved debt grants in a post-conflict relief under the MDRI ~ setting. External BS b% $90 m/ year accounts for +/ - 50% of budget. Exogenous, short-term Exogenous, one-shot
The fiscal space diamond as a diagnostic tool End ogenous, one-shot End ogenous, short-term a% 2. Domestic Revenues b% a- Tax and Non-Tax. Tax effort and institutional measures including creation of National Revenue b- Enhanced Privatization Administration yield + 0.7% of GDP in Receipts . Several States 2005 (at 13%) and expected another +0.3% in 2006 as result of new Enterprises for Sale. Question of measures. Increase in absolute terms use of additional funds if revenues fuelled by solid GDP growth (7%/ year). exceed budgeted amounts: debt Question of tax-arrears of SOEs. reduction or poverty-related outlays?
The fiscal space diamond as a diagnostic tool a- Prioritization: b- ‘Value-for-money’. PFM measures (i) Military spending (not limited to effect on revenue reduced from 4 to 3.5% effort). between 2001 and 2003. a% Further decline? b% 4. Reprioritization and Efficiency of d% Expenditure c% ii) Recurrent expenditures ( (wages) represent 20% of GDP vs. 4% for investment. Poverty-related (PR) spending meant to be increased relative to End ogenous, short-term non-PR recurrent spending
The fiscal space diamond as a diagnostic tool End ogenous long-term a% 2. Domestic b% Revenues c% 3. Deficit Financing a- Net domestic financing of the budget has increased in past years. Increase in the share of domestic debt, which is almost exclusively short-term. High interest rates. Exogenous, long-term b- External financing should take account of fragile debt position in the aftermath of the HIPC/ MDRI initiatives. The IMF suggests that external financing should take the form of grants (see 1) or highly concessional loans. GDP growth may create some ‘fiscal sustainability- consistent’ space
The fiscal space diamond as a diagnostic tool 1. ODA Endogenous, one-shot a- Aid. External b- Debt Relief. Endogenous, short-term a% budget support Completion point 2. Domestic a% subject to volatility reached under the b% Revenues and projected Enhanced HIPC b% gradual decline in initiative and a% foreign grants in a approved debt relief a- Tax and Non-Tax. Tax effort and post-conflict b- Enhanced under the MDRI ~ institutional measures including setting. External Privatization Receipts. $90 m/year creation of National Revenue Several States BS accounts for +/- Administration yield + 0.7% of GDP Enterprises for Sale. 50% of budget. in 2005 (at 13%) and expected Question of use of another +0.3% in 2006 as result of additional funds if new measures. Increase in absolute revenues exceed terms fuelled by solid GDP growth budgeted amounts: debt (7%/year). Question of tax-arrears of reduction or poverty- Exogenous, short-term SOEs. related outlays? Exogenous, one-shot b- ‘Value-for-money’. PFM measures Endogenous long-term a% a- Prioritization: 2. Domestic (not limited to effect on revenue effort). b% (i) Military spending reduced Revenues a% c% from 4 to 3.5% between 2001 and 2003. Further decline? a- Net domestic financing b% 3. Deficit of the budget has increased 4. Reprioritization Financing d% in past years. Increase in and Efficiency of c% the share of domestic debt, Exogenous, long-term Expenditure which is almost exclusively short-term. High interest (ii) Recurrent expenditures (wages) rates. represent 20% of b- External financing should take account of fragile debt position in the GDP vs. 4% for investment. aftermath of the HIPC/MDRI initiatives. The IMF suggests that external Poverty-related (PR) spending Endogenous, short-term financing should take the form of grants (see 1) or highly concessional meant to be increased relative to loans. GDP growth may create some ‘fiscal sustainability-consistent’ non-PR recurrent spending space
Savings in France and United Kingdom 1946-1960 1946-1951 1948-1951 1952-1960 France n.a. 19 27 UK 9 13 16 Note: Savings are calculated as the sum of investment and the current account surplus Source: Barry Eichengreen, (1995) Marshall aid (80% grants created fiscal space) More recently similar experience in Thailand
The challenge for achieving sustainable development across different income groups differs significantly (this impacts the uses of fiscal space and, conversely, long term fiscal solvency)
Main challenges Address inequality=> increase access of the relatively poor to key public goods; here public goods are available- the problem is affordability Manage downsides caused by structural shocks
Pro development fiscal policy implies attention to sta bilisa tion and a lloca tion functions Objective 1: Fiscal space for income transfers and improvement in quality of public good provisioning (e.g. reducing class sizes in schools) Objective 2: Counter cyclical fiscal policies
No permanent increase in the size of government (G/GDP ratio) or PSBR Expenditure switching policies and temporary deficits main instruments
Main challenge: permanent and significant increase in public expenditure to secure economic growth and enhance human development Time horizon: 10 to 20 years
The emphasis here is on grow th and a lloca tion functions o f fiscal policy Typically implies a permanent increase in G/GDP ratio. Consistent with Wagner’s law
Needed a hierarchy of instruments to enhance fiscal space in different development contexts
G/GDP ratio over 40% in OECD countries, 28% in MICs and 23% in LICs Tax/GDP ratio 38% in OECD countries, 25% in MICs and 19% in LICs Thus the instrument mix chosen to secure fiscal space in correlated with the level of development of a country.
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