The Macroeconomics of Financing Basic Utilities for All

1
The Macroeconomics of Financing Basic Utilities
for All

• Terry McKinley
• Director, International Poverty Centre
• Financing Access to Basic Utilities for All
• Multi-Stakeholder Consultation, Lusaka, 23-25
  April 2007

2
Some Research Background

• UNDP has supported 25 national reports on
  Economic Policies for Growth, Employment and
  Poverty Reduction since 2002
• The motivation has been to promote greater policy
  dialogue and provide policy alternatives on
  economic policies
• www.undp-povertycentre.org/reports.htm
• Coverage Asia-Pacific, Eastern Europe and the
  CIS, Middle East, and sub-Saharan Africa
• Focus a) fiscal, monetary and exchange-rate
  policies and b) financial liberalization, trade
  liberalization and privatization
• UNDP has also supported a global project on
  Privatization and Poverty Reduction (most
  studies are in low-income countries in Africa)

3
The Conclusion of the Studies

• Privatisation and commercialisation of public
  services are often not compatible in low-income
  countries with achieving the Millennium
  Development Goals
• See Working Paper 22 of the International
  Poverty Centre Can Privatisation and
  Commercialisation of Public Services Help Achieve
  the MDGs An Assessment? www.undp-povertycentre.o
  rg
• Also see the IPC Policy Research Brief 3
  Privatising Basic Utilities in Sub-Saharan
  Africa the MDG Impact and the ensuing debate in
  One Pagers
• Central Questions How will access to public
  servicessuch as water, sanitation and
  electricitybe financed? What are the
  Macroeconomic Implications?

4
Access to Electricity Percentage of Population
Region 1970 Total 1990 Total 2000 Total 2000 Urban 2000 Rural
Africa 14 25 34 63 17
S. Asia 17 32 41 68 30
E. Asia 30 56 87 98 81
Latin America 45 70 87 98 51
All Developing 25 46 64 86 51
5
Access to Electricity The Need for Public
Investment

• How to reach households without electricity?
• Two-thirds of households in Africa83 in rural
  areas?
• 59 of households in South Asia70 in rural
  areas?
• We have to dramatically scale up public
  investment in order to expand the electrical grid
  or provide alternative cheaper sources of energy
• Costing the public investment needed to reach the
  MDGs has provided a stronger impetus for a change
  in strategy
• A greater need for Economic Policies that support
  Rapid Growth and Economic Development, not just
  Macroeconomic Stabilization

6
The Need for Public Investment-Led Economic
Policies

• According to conservative economists, increased
  Public Investment will
• Crowd out (displace) private investment
• Cause accelerating inflation and appreciation of
  the exchange rate
• Increase the Fiscal Deficit and the Public Debt
• Public Investment Has Been in Long-Term Decline
  (See graph) From 10 to 7 of GDP

7
Public Investment in Developing Countries,
1970-2000 (as a share of GDP)
8
Why Is Increasing Public Investment Justified?

• It will stimulate private investment, not dampen
  it (example electricity)
• It will increase the productive capacity of the
  economy so that inflation is contained
• Governments should borrow to finance public
  investment (deficit financing)
• It creates future revenue and welfare benefits
• Current revenue should cover current expenditures
• So incurring deficits is normal for investment
  purposes (ODA finances larger deficits)

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The Macroeconomic Implicationsof Expanding Basic
Utilities

• Fiscal policies need to be more expansionary
  (investment focused)
• Monetary policies should be consistent with
  fiscal expansion
• Low inflation targets (3-5) can be
  counter-productive
• Achieving such targets can drive up real rates of
  interest
• Such interest rates slow private investment and
  make public borrowing more expensive the result
  is a vicious circle

10
What Are the Alternative Sources of Financing?

• For low-income countries, a dramatic scaling up
  of Official Development Assistance is needed
• Such a scaling up need not endanger macroeconomic
  stability (e.g., accelerating inflation and
  causing a Dutch Disease appreciation)
• Refer to the Conference Papers from the
  IPC-supported Global Conference on Gearing
  Macroeconomic Policies to Reverse the HIV/AIDS
  Epidemic
• www.undp-povertycentre.org/aids.htm
• Conclusions 1) concerns about instability are
  inflated and 2) if there are such problems, they
  can be managed.

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Investment-Focused ODA

• See the New IMF Analytical Framework
• ODA should be SPENT the Government should
  spend more based on ODA financing of a larger
  deficit
• ODA should be ABSORBED the Central Bank should
  sell the ODA-supplied foreign exchange in order
  to finance imports
• Otherwise the purpose of ODA is defeated

12
Investment-Focused ODA

• The recent 2007 Evaluation of PRGF countries in
  sub-Saharan Africa by IMFs Independent
  Evaluation Office found
• Governments spent only 28 of ODA (72 was saved)
• So almost three-quarters of ODA was not used for
  development purposes!!!
• Worse still, if the inflation rate exceeded 5 in
  a country, only 15 of ODA, on average, was spent
  by governments

13
Monetary Policies and Inflation

• But IMF now recognizes that inflation rates of
  5-10 need not be harmful to growth
• Maintaining inflation rates of 3-5, as in the
  past, can often be unduly restrictive
• Empirical evidence suggests that even inflation
  rates up to 15 are not likely to be harmful
• Supply shocks (oil food) can temporarily drive
  inflation rates above 10

14
Inflation Has Declined in AfricaIt has been
5-10 since 1997
15
The Impact of ODA

• Central Banks Absorbed only 63 of ODA (i.e.,
  sold foreign exchange)
• 37 of ODA was used to build up International
  Reserves
• There are three possible uses of ODA
• Central Bank Reserves
• Private Capital Outflow
• Financing of Imports (a transfer of real
  resources widening the current account)

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Using ODA Effectively

• Is it justifiable to use ODA to build up
  reserves?
• Reserves substitute for the transfer of real
  resources into the country
• A modest build-up could be warranted as a means
  to address Aid Volatility
• The Problem Central Banks sterilize the
  monetary impact of ODA, driving up interest rates
  in order to contain inflation

17
A Danger of Exchange-Rate Appreciation??

• The IMF hypothesis
• More government spending domestically (on
  non-tradables) increases inflation
• Inflation appreciates the exchange rate
• Appreciation damages the international
  competitiveness of exports
• But in sub-Saharan Africa (as in Asia) aid surges
  have been associated with Depreciation (See Graph)

18
The Size of Aid Is Correlated with Depreciation
in Africa
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A Danger of Exchange-Rate Appreciation??

• The danger of inflation depends on the supply
  response to increased demand
• Fiscal policies (that increase government
  spending) and monetary policies (that sell
  foreign exchange) need to be coordinated
• (see IPC Working Paper 10 Conference Papers)
• But coordination of policies on whose terms?
• Fiscal policies have to be consistent with the
  restrictive monetary policies of the Central
  Bank???

20
Policy Coordination for Scaling Up

• Choose the opposite monetary policies should be
  supportive of expansionary fiscal policies
• Short-term inflation and even some appreciation
  could be part of the adjustment process
• Relative prices need to adjust in order to
  transfer resources domestically and facilitate
  their import into the country
• The exchange rate can be managed to deal with
  such short-term problems (along with coordinating
  fiscal and monetary policies)

21
The Problem of Aid Volatility

• The volatility of aid is the chief problem, not
  so much domestic macroeconomic instability
• ODA needs not only to be scaled up but also made
  predictable
• Otherwise it imparts instability to the budgeting
  process and contributes to macroeconomic
  instability