Fiscal Space, Expenditure Composition and Aid Effectiveness

1
Fiscal Space, Expenditure Composition and Aid
Effectiveness

• John Page
• November 2005

2
The Problem

• To achieve the MDGs in low-income countries,
  countries need large and sustained aid increases
  on the order of 25-120 billion annually
• For Africa 40 percent of the increase is for
  health
• Countries require investments in multiple sectors
  to generate growth and produce human development
  outcomes, including health.
• Donor agencies have promised the extra aid
  required- total aid up 62 by 2010, aid to
  Africa more than doubled
• But past aid surges have not been sustained -
  the Resource Boom literature shows benefits of
  revenue surges are negligible transitory but
  costs are large long-term
• Moreover, there are serious problems with aid as
  currently provided short maturity, volatility,
  off-budget nature, earmarking, lack of
  predictability, fungibility

3
The Magnitude of the Problem is Huge
4
Investments are Needed Across Several Sectors to
Optimize Outcomes
growth government health spending
0
3
5
8
10
13
15
0
0
5 economic growth
-10
-10
2.5 female education growth
2.5 roads growth
-20
-20
2.5 water sanitary growth
-30
-30
2.5 growth in all
reduction U5MR 1990-2015
-40
-40
-50
-50
-60
-60
-70
-70
5
Domestic Tax and Non-Tax Revenue Will Increase
Only Slowly

• Average rate of growth in total revenue as
  percentage of GDP in the 1990s Selected African
  countries

6
Predictability and Longevity of ODA Must Be
Improved
Try managing this
7
ODA is Rising But is Well Short of What is Needed
-- 0.54 percent of GNI to Meet the MDGs and 0.70
to Fulfillthe Monterey Commitments
Prospects for ODA in 2006 and 2010 are based on
DAC members post-Monterrey announced
commitments. Not all DAC members have made
commitments beyond 2006. Source OECD DAC
database.
8
DAH has Increased Significantly but is Short of
What is Needed to Reach the MDGs is Largely
Earmarked
9
Fiscal Sustainability is a Critical Concomitant
of Aid Commitments and Country Actions

• Generally defined in terms of self-sufficiency --
  over a specific time period, the responsible
  managing entity will generate sufficient
  resources to fund the full costs of a particular
  program, sector, or economy including the
  incremental service costs associated with new
  investments and the servicing and repayment of
  external debt.
• The capacity of the health system to replace
  withdrawn donor funds with funds from other,
  usually domestic, sources
• The sustainability of an individual program is
  defined as capacity of the grantee to mobilize
  the resources to fund the recurrent costs of a
  project once the investment phase has ended
• A softer definition is that the managing entity
  commits a stable and fixed share of program costs

10
Fiscal Space is Needed to Scale Up Spending

• Fiscal space is
• availability of budgetary room that allows a
  government to provide resources for a desired
  purpose without any prejudice to the
  sustainability of a governments financial
  position

• Fiscal space can be created by
• tax measures and better administration
• reducing lower priority expenditures
• borrowing domestically or externally
• seignorage
• grants

Source Heller, 2005
11
Visualizing Fiscal Space
12
Fiscal Sustainability and the Composition of
Expenditure

• Composition of expenditure matters along a number
  of dimensions
• Debt service vs. primary expenditure
• Consumption vs. investment
• Allocation across sectors
• Salaries vs. Operations and maintenance
• For fiscal sustainability, are governments
• spending adequately on investments that will
  spur long term growth?
• Ensuring that the investments will enhance govt.
  revenues to pay for any debt and running costs?
• Maintaining and operating public investments to
  ensure a productive return to investment?

13
Country Case Examples

• Ethiopia Faced with large deficits in
  infrastructure and human capital, simulations
  show how alternative allocations of grant aid
  would affect poverty and other MDG outcomes.
• Brazil investment collapse in a context of
  rising taxes and current expenditure. Simulations
  show that most promising strategy is change in
  the composition of expenditure from current to
  capital.
• Colombia sustained public investment in a weak
  fiscal situation with high insolvency risk.
  Simulations show that investment compression is
  inferior to tax hikes as adjustment strategy.
• All cases show that (i) spending composition is
  key and (ii) initial conditions matter for
  fiscal choices.

14
A Key Result from the Ethiopia MDG Case Study
reComposition of Public Expenditures, MDG
Trade-offs and Aid Levels

• Increasing the share of infrastructure spending
  (from left to right) will improve the prospect of
  growth and hence the poverty outcome relative to
  the MDG target.
• However, there is a point where the share to the
  HD outcomes relative MDG targets will start to
  decline (and vice versa).
• A higher level of aid will of course reduce the
  trade-offs.

15
The World Banks Work Program for MDG Pilot
Studies and Fiscal Space in the Africa Region

• MDG analysis the plan is to extend the MDG
  Pilot Studies (using MAMS or other macro-micro
  approaches) to other countries such as Burkina
  Faso, Ghana, Guinea, Kenya, Madagascar, Malawi,
  Mozambique, Namibia, Niger, Rwanda, South Africa,
  Uganda, Zambia etc.
• The overall purpose is to derive the
  implications to growth and MDGs given a countrys
  PRS, expected aid flows, policy reforms, costing
  and sectoral composition/prioritization in the
  MTEF, and what can be reasonably scaled up and
  how to increase absorptive capacity, fiscal space
  etc.
• The approach is practical and will ground the
  analysis in the policy coordination and process
  to support a countrys PRS and to monitor the
  progress and results periodically no single path
  and policy dialogue is key.

16
Conclusions

• While aid is projected to increase, much more
  needs to be done by both donors and countries.
• There is no silver bullet. Development is a
  process and fiscal space is constrained.
• Expenditure compositions are important to
  generate growth and human development outcomes.
• Decisions on health spending will be an important
  element of such choices and conversely,
  health-sector specific decisions by donors may
  have important implications for fiscal space
  under certain circumstances (e.g., increased
  spending on the wages of health workers).
• We must work with countries which must be in the
  drivers seat. The best approach is through PRSP
  informed by PERs and PETs, sector strategies that
  are costed and aligned with PRSPs, and working
  all together within an appropriate Medium Term
  Expenditure Framework.
• Donors can play a fundamental role in LICs but
  the characteristics of donor funding need to
  change dramatically more budget support, longer
  term, predictable and following the recipient
  countries mandates or plans rather than
  unilateral mandates.