Infrastructure and Fiscal Policy Specific Challenges

1
Infrastructure and Fiscal PolicySpecific
Challenges

• Marianne Fay
• Many thanks to Vivien Foster on whose 2005 PEAM
  course presentation this is largely based

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Outline

• Stylized facts
• Funding sources
• Budgetary boundaries
• Budgetary mechanisms

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I. Stylized facts
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Infrastructure is big money

• Stocks
• Equivalent to about 100 of developing country
  GDP
• Dominated by electricity (45-55), and transport
  (30 to 40)
• cheaper telecom (5-15 and growing) and WS (5
  to 15)
• Maintenance
• About 2 to 3 of GDP per year

5
Infrastructure is big money

• Output
• About 6 of GDP for electricity (MICs)
• The same for telecom transport?
• Much smaller for WS

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Expensive when poorly managed

• Electricity
• Total hidden costs (underpricing technical and
  commercial losses) estimated in ECA at 4 of GDP
• In Mexico untargeted subsidies amount to 1 of
  GDP
• Rail and public transport historically huge
  drains on public coffers
• Water and sanitation typically much smaller
  (0.4 of GDP in ECA)

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Much of it, public responsibility

• Differences across sectors
• Fairly universal trend for privatization of
  telecom, air transport, possibly rail
• More varied with electricity, public transport
• Limited potential for roads
• WS complicated

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Distinguishing features

• Investment
• Highly capital intensive (60)
• Long term planning horizons (30 yrs)
• Infrequent lumpy investments
• Long lead times (Up to 5yrs)
• Unpredictable investment costs

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Distinguishing features

• Maintenance
• Long asset lives (Up to 30 yrs)
• High maintenance (2-3 AV)
• Exponential cost of deferred maintenance
• Catch-22
• Decision to invest based on estimated rate of
  return, itself conditioned by whether maintenance
  occurs

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The maintenance dilemma
100
Very Good
90
-Filling Cracks
80
70
Good
-Geotextile and Strengthening
60
Condition of Pavement ()
-Reconstruction of the Surface -Reconstruction of
the partial base course
Fair
50
40
Poor
-Complete Reconstruction
30
20
Very Poor
10
0
0
2
4
6
8
10
12
14
16
18
20
22
24
26
Lifetime of Pavement (years)
If maintenance on a 20 year road is not
done by the end of the 12th year. It starts to
deteriorate eight times faster than in the early
years
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Fiscal consequences

• For all of these reasons, ill-suited to
  unpredictable annual budgetary cycle
• Moreover, particularly vulnerable to budgetary
  downturns
• Politically soft target for budget cuts
• Maintenance less attractive than investment
• Long lived assets delay hour of reckoning
• Even investments can always be deferred

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The infrastructure public finance paradox

• Maintenance and investment are prime candidates
  for cuts
• Subsidies however poorly targeted - are
  difficult to eliminate
• Some countries spend more on consumption
  subsidies than on either investment or
  maintenance

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A complication no data

• No country systematically collects investment
  data on infrastructure
• infrastructure a broad and vague category
  unlike health and education
• Poor fit with IMF GFS categories
• Public investment data notoriously poor hard to
  distinguish from OM
• A few valiant efforts (Calderon Serven
  specific country studies)
• The implication no monitoring

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II. Funding sources
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Only three possible sources

• Tax payers (fiscal transfers)
• Users
• fees
• cross-subsidies
• Asset depletion
• quality
• non-expansion of service

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Historic under-pricing
Ratio of revenue to costs
Source WDR 1994
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Cost recovery water
Degree of cost recovery
Source Foster Yepes, forthcoming
18
Cost recovery electricity
Degree of cost recovery
Source Foster Yepes, forthcoming
19
Who really gets the subsidy?
In Hyderabad (India), employees capture 40 of
the subsidy, and consumers 60, half of which
they spend on alternative providers
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What distributional incidence?
Source Komives et al., forthcoming
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III. Budgetary Boundaries
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Budgetary boundaries

• Infrastructure has a tendency to creep off the
  budget for both good and bad reasons
• There are a number of mechanisms through which
  this takes place
• Extra-budgetary funds (fuel tax, USL)
• State Owned Enterprises
• Public Private Partnerships

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Earmarked funds

• Loved by sectoralists?provide a stable source of
  financing in sectors without possibility of user
  fees, isolated from budgetary and political
  interference
• Loathed by macroeconomists?reduce budgetary
  flexibility and optimization of public resources,
  often lead to poor governance, lack of
  transparency

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Argentina exploding funds
Source Argentina PER, 2003
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Argentina weak governance
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State Owned Enterprises

• Often represent a large percentage of public
  investment in infrastructure
• May or may not be consolidated into fiscal
  accounts
• May be net contributors or drains on the public
  purse
• Operate in restricted environments that limit
  their autonomy and commercial orientation
• Management may be guided by macroeconomic concerns

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Colombia drains vs. cash cows
Source REDI Colombia, 2004
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Public Private Partnerships

• Potential for PPPs varies substantially across
  sectors
• Key criterion for judging whether extra-budgetary
  is extent of risk transfer
• However, unless 100 risks can be transferred
  contingent liabilities remain
• Complex fiscal accounting issues arise regarding
  the treatment of
• Contingent liabilities
• Private investment
• Committed future public subsidies

29
LAC private relative to total
Source Calderon, Easterly and Serven, 2003
30
LAC private relative to total
31
Colombia new policy after 4.4 Bn bailouts

• New policy guidelines on risk allocation between
  public and private partners
• Mandatory estimation of contingent liabilities
  using Monte Carlo (continuously updated)
• Required payments to cover liability are
  smoothed out into a Deposit Plan
• Deposits are made from budget to Contingency Fund
  in individual accounts
• Aggregate estimates reported annually to
  parliament (infrastructure gt0.5 GDP)

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IV. Budgetary mechanisms
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Budgetary challenges

• Project selection?deficiencies in technical
  capacity for project evaluation, plus political
  attraction of white elephants
• Multi-year planning?long term projects required
  multi-year budget envelope to assure execution
• Implementation bottlenecks?complex procurement
  plus unforeseen delays cash budgeting! make it
  difficult to execute budget

34
Peru project selection

• SNIP
• MinFin unit does (pre-)feasibility studies
• CBA methodology with min. IRR 14
• Declares viability without prioritization
• Coverage
• 2/3 of projects with regulated exceptions
• Smaller local projects with domestic financing
• Projects supported by Supreme Decree
• Too many projects leads to budget constraints,
  delays and declining IRRs

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Colombia low execution
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Conclusions

• Cost structure of infrastructure services leads
  to fiscal complications
• Wide variety of potential funding sources for
  infrastructure
• Tendency for infrastructure to be on the
  boundaries of the budget
• Infrastructure poses challenges from a budgetary
  perspective