Fiscal Policy, Fiscal Space and Financing of Development Goals

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Fiscal Policy, Fiscal Space and Financing of
Development Goals

• The Role of Fiscal Policy for Growth,
  Distribution and Poverty Reduction

Anuradha Seth Policy Dialogues on Inequality
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Outline

• Examine the role assigned to fiscal policy in
  low-income countries
• Explore the concept of fiscal space and examine
  its usefulness for discussions on development
  finance
• Key policy messages

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Fiscal Policy

• In the 1980s and much of the 1990s
• Focus was on managing macro-economic stability
• Ignored conditions needed to sustain economic
  growth

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Public Investment
Public Investment by Developing Region, 1970-2000
(as a share of GDP, weighted averages)
Source Everhart and Sumlinski (2001). Page 2
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Renewed Interest in Fiscal Policy

• Reasons for resurgence of fiscal policy
• Adoption of long term poverty goals by the
  international development community
• Need to secure finance to achieve MDGs
• Discussions around the financing for development
  agenda (Monterrey Consensus)

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Public Expenditure and Growth

• Research shows a significant and positive
  relationship between public expenditure and
  economic growth
• Capital expenditure, as well as spending on
  education, health, transport and communication,
  has been shown to be favorable to growth
• However, the impact of public expenditure on
  growth is dependant on country specific factors,
  such as efficiency of resource use and the
  quality of governance

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Fiscal Space and Financing Development

• According to Heller (2005)
• Fiscal Space is defined as the availability of
  budgetary room that allows a government to
  provide resources for desired purpose without
  prejudice to the sustainability of a governments
  financial position

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Fiscal Space and Financing Development

• Indicator used to measure fiscal sustainability
  is deficit/GDP ratio
• Thus, expansion of fiscal space is only desirable
  when it does not compromise short-term
  macro-stability
• Expansion of fiscal space seen as incremental

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Need for a Long Term Perspective

• To emphasize the need for a longer term
  perspective an alternative definition has been
  proposed
• Fiscal Space is the financing that is available
  to government as a result of concrete policy
  actions for enhancing resource mobilization, and
  the reforms necessary to secure the enabling
  environment for these policy actions to be
  effective, for a specified set of development
  objectives

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Fiscal Space Diamond
1. ODA (/GDP)
4. Reprioritization Efficiency of Expenditures
(/GDP)
2. Domestic Revenues Mobilization (/GDP)
3. Deficit Financing (/GDP)
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Domestic Resource Mobilization

• Over the long-term, resources to finance
  development must rely primarily on domestic
  revenue
• Domestic resource mobilization will require
  significant reforms in both the structure and
  administration of the tax system

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Government Revenue Collection
Pacific
Asia
(2006 of GDP)
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Scope for Mobilizing Domestic Revenue

• Fiscal space assessments indicate potential for
  enhanced domestic revenue (Example Bhutan)
• Building capacity for a reliable personal income
  tax information system
• Taking measures to reduce sales tax evasion
• Ensuring compliance of business tax
• Bhutan notes that improving the revenue
  productivity of the tax system could generate
  additional fiscal space by 4-5

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Reprioritization and Expenditure Efficiency

• Increasing expenditure efficiency is often
  suggested as the main instrument for enhancing
  fiscal space
• Expenditure switching and efficiency enhancing
  reforms can create fiscal space through
• Reallocation of resources from a lower to higher
  priority
• Productive efficiency gains
• Efficiency gains must be weighted against
  distributive concerns (benefit/expenditure
  incidence)

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Scope for Enhancing Fiscal Space Through
Reprioritization and Expenditure Efficiency

• A review of Bhutans expenditure policy showed
• Accelerated progress could be made towards the
  realization of poverty reduction if govt
  reoriented some resources for spending in the
  social sectors
• Declines in the expenditure to GDP ratio were
  lowest in the case of general administrative
  services and highest in economic services
• Expenditure on social services decelerated
  sharply from 22 (1995-2000) to 12 (2001-2006)

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Official Development Assistance

• Asias top net ODA recipients were Vietnam,
  Indonesia, Afghanistan, Bangladesh, China, the
  Russian Federation, Pakistan, India, the
  Philippines, and Sri Lanka
• These 10 countries received 72 of Asias net ODA

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ODA as a Transitional Strategy

• Current discussions on development finance focus
  on ODA as the primary mechanism for scaling up
  public spending
• IFI note that debt relief and scaling up of aid
  to low-income countries should allow greater
  fiscal space for expenditure programmes
• However, ODA should be seen as a transitional
  strategy for financing development

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Borrowing as a Source of Fiscal Space

• Borrowing is typically considered the least
  desirable option (see Heller definition)
• Concern is that scaling up public expenditure
  through borrowing can raise fiscal deficit and
  jeopardize macro-economic stability
• Reason for such concern is because of adoption of
  short-term perspective
• For a long-term perspective, it is important to
  ask Borrowing for What?

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Borrowing that Enhances Growth

• Some kinds of investments/expenditures can be
  growth enhancing
• Such spending must be relatively efficient in
  creating public sector outputs and services that
  either directly or indirectly have high economic
  returns
• Development payback over longer term can
  compensate for short-term concerns

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Policy Messages

• Financing development will require a substantial
  scaling up of public expenditures from current
  levels
• Public expenditure particularly in infrastructure
  and for health, education, agriculture, water and
  sanitation have been shown to have positive
  effects on economic growth and poverty reduction

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Adopting a Long Term Perspective

• ODA should be seen as an interim strategy
• There is considerable room to amplify fiscal
  space by undertaking necessary reforms to enhance
  productivity of revenue collection and
  expenditure efficiency
• Borrowing for investments that are productive in
  the long-term should not be ruled out because of
  short-term stability concerns