Fiscal Policy: Issues,

Dimensions and Dilemmas

K. Seeta Prabhu
UNDP India

Oxford Human Development Course

24 September 2008
 Structure of Presentation

 The Context
 Fiscal Space
 Goals and Instruments
 Challenges
 The Context

 Globalisation and rising inequalities

 Fiscal compression and declining public
investment in countries
 Imperative of reaching MDG goals and
targets
 Fiscal policy direct means of influencing
human development
 Structural Adjustment

 Historical context important - Structural Adjustment

Policies during 1980s – preoccupation with limiting
fiscal deficit
 Countries resorted to expenditure compression
rather than raising revenues
 Capital expenditures affected most - sub-Saharan
Africa (SSA) worst hit
 Total government expenditure on infrastructure in
43 developing countries increased only by 7%
between 1980 and 1998 – Fan and Rao 2003
 Private sector did not compensate for shortfalls in
public investment
 Declining Public Investment in
Developing Countries 1970-2000
 SSA- Slow Progress in HD Attainments
 Growth rate of GDP per capita 1975-2005 was -0.5% for sub Saharan Africa
compared to 6.1% for East Asia and the Pacific

 HDR 2007/08 data - Public expenditure on education (% GDP) declined

between 1991 and 2002-05 in many countries
 Niger: 3.3 to 2.3%; Zambia: 2.8 to 2.0%; Tanzania – 2.8 to 2.2%

Gambia: 3.8 to 2.0%

 1985-1994- at regional level only marginal increase in Adult Literacy Rate

from 54.2% to 59.3%

 1970-75 to 2000-05 - decline in IMR– 144 to102; average for least

developed countries 152 to 97

 1990-2004 population with access to improved sanitation increased only 32

to 37%, with improved water source increased only 48 to 55%
 SSA- Slow Progress in HD Attainments

 Development Committee, 2006- Structural

Adjustment Programs have achieved short term
macroeconomic stability at the expense of long
term human development
 Belief that private sector will step in when public
sector investment declines was misplaced
 The Report of the Commission for Africa
(2005) sharp reduction in infrastructure
investment was a policy mistake founded in a new
dogma of the 1980s and 1990s asserting that
infrastructure would now be financed by the
private sector
 Goals of Fiscal Policy
 Necessary to revamp fiscal policies towards developmental
goals
 UNDP position for developing countries based on expanding
fiscal space for human development
 Fiscal space definition varies according to approach adopted
 UNDP -Roy, Heuty, Letouze, 2007
‘the financing that is available to government as a result of
concrete policy actions for enhancing resource
mobilisation, and the reforms necessary to secure the
enabling governance, institutional and economic
environment for these policy actions to be effective, for a
specified set of development objectives’.
 Different from the IMF definition of fiscal space which is ‘the gap
between current level of expenditure and the maximum
level of expenditures a government can undertake without
impairing its solvency’ (Development Committee 2006)
 Goals of Fiscal Policy

 IMF focus on
 short term goals

 maintaining fiscal stability

 incremental resources approach

 UNDP focus on
 long term developmental objectives

 resource needs for attaining MDGs

 ‘transformational change’ rather than

incremental change
 Fiscal Rules
 Using the UNDP approach the fiscal rules in developing countries are

 Zero current deficits

 Focus on domestic resource mobilisation – ODA as a tide over mechanism

 Efficiency gains and expenditure switching necessary but insufficient tools for
enhancing fiscal space

 instruments used differ for middle income and poor countries – growth and
allocation functions of fiscal policy more important in developing countries –
hierarchy of instruments

 Fiscal Space Diamond – 4 pegs

 Domestic Resource Mobilisation
 Reprioritization and Efficiency of Expenditures
 Deficit Financing
 ODA
 Domestic Resource Mobilisation

 Includes privatization receipts, tax and non-

tax revenue collection
 Should/can tax/GDP ratio be increased? If so,
how can this be done while ensuring that the
burden on the poor is minimized?
 Should VAT be introduced if absent?
 To what extent is privatization of public assets
feasible without undermining MDG
achievement?
 Domestic Resource Mobilisation

 Developing Countries – Challenges in raising tax revenue

arise from
 Large informal sectors – transactions not fully accounted for

 Narrow and rigid tax structure– lower tax-GDP ratios and

greater reliance on indirect taxes rather than direct taxes
 Banking sector not fully developed, credit markets are
imperfect
 Weak institutions

 Financial – unable to mobilize & channel savings

 Political – weak governance structures – unable to take

tough decisions regarding raising revenues and plugging
leakages in tax collection
 Domestic Resource Mobilisation
 Low and unstable revenues in developing countries – Jha 2007
 Tax-GDP ratios 1996-2002

 Developed countries – 33.8%, Transitional countries –

31.4%, Developing countries – 19.2%
 < one third of tax revenue from income taxes (developed
countries >50%)
 Unstable tax revenues - coefficient of variation in in Latin
America - 55% (developed countries-15-17%)
 Imperative to increase tax-GDP ratios over the medium and long run
and ensure stable tax base
 Overall resource base to be enhanced through
 Encouraging savings and its investment in domestic economy

 Increased employment intensity and capital accumulation

 Using privatisation revenues & revenues from commodity price

boom for pro-poor initiatives
 Reprioritization & Efficiency of
Expenditures

 Includes reprioritization based on the extent

expenditures contribute to MDGs and value-
for-money considerations:
 What is the ratio of current/capital expenditures?
 What is the share of expenditures that can be
classified as pro-poor?
 To what extent can the government enhance the
value for money for goods and services it
provides?
 Reprioritization & Efficiency of
Expenditures
 Human Development Expenditure Ratios – 4 ratios in
1991 HDR
 The Public Expenditure Ratio (PER) ratio of public
expenditure to national income – (necessary to
distinguish between current and capital expenditure)
 Social Allocation Ratio (SAR): the percentage of public
expenditure earmarked for social services – (necessary
to include essential infrastructure – dichotomy between
social and economic self defeating)
 Social Priority Ratio (SPR): the percentage of social
expenditure devoted to human priority concerns
 Human Expenditure Ratio (HER): the percentage of
national income devoted to human priority concerns
 Reprioritization & Efficiency of
Expenditures
 The 1991 report - stated that a
 Public Expenditure Ratio at around
25%, Social Allocation Ratio at 40%,
Social Priority ratio at 50%, and Human
Expenditure ratio at least at 5%
necessary to ensure adequate resources
for human development priority sectors in
a country
 Reprioritization & Efficiency of
Expenditures

 Norms as a guide posts but same levels of expenditure

result in different levels of attainments
 Pattern of expenditure and efficiency of use most
important – time span over which investments made
important
 Different Adult literacy rates and education expenditures
(% of GDP – HDR 2007/08)
Adult lit Exp
 Rwanda 64.9% 3.8%
 Malawi 64.1% 5.8%
 Indonesia 90.4% 0.9%
 China 90.9% 1.9%
 Pattern of Expenditure

 Data from 55 studies in 25 developing countries

on central government spending – Chu et al 2000
 Education & Health
 Education well targeted in Asia & Latin America and
poorly targeted in SSA, middle East & transition
economies
 Primary education well targeted, secondary – mixed
picture across regions
 Tertiary education mostly benefits the richest quintile
 Health spending poorly targeted in SSA and transition
economies
 Plugging Leakages

 Transparency and accountability of governance

structures important – high level of leakages limit
benefits from expenditure
 Uganda- Public Expenditure Tracking Survey
(PETS) supported by World Bank enabled the
reduction in leakages in primary education
grants between 1991-95 and 2001 from 90% to
20%
 Right to Information campaigns in India have
detected leakages in government programmes
 Cash Transfers
Successful examples of subsidized targeted
programmes
 Food stamps in Jamaica, Tunisia – tackling food
security
 Conditional cash transfers in Latin America –
addressing human poverty
 Fertiliser coupons in Malawi – success story in
2006 and 2007- stands conventional wisdom on
its head – ensures food security
 NREGA in India – generating employment
 New ways of thinking – local solutions emerging
for enhancing human development – failure of
‘one size fits all’ approach
 Deficit Financing

 Deficit financing - includes net domestic financing,

net foreign financing:
 What are the needs for public investment?
 What is the case/room for additional borrowing?
 What is the level of internal and external debt? Access to
international capital market?
 What is the level of investments and savings? To what
extent do the savings contribute to investments?
 If savings are low, why? How to reduce obstacles to
savings? How to improve channelling of savings for
public investment?
 Deficit Financing
 Zero current / recurrent deficits as a target over the
economic cycle
 Move from notion of ‘Fiscal squeeze’ and expenditure
compression to ‘Fiscal Space’
 RBAP studies in 7 countries - high public investment
does not seem to have had any adverse effect on fiscal
deficit during the 1990s and early 2000s
 Examples of China, Cambodia, Mongolia and Vietnam -
experienced deflation or near deflation – fiscal deficit in
these countries ranged between 4-9%
 Vietnam - poverty fell from 58% to 37% between 1993-
98- per capita income growth 5% - inflation continued to
decline during 1996-2002 towards zero and fiscal deficit
4%.
 External Support

 Includes grant aid and debt relief

 What is the medium and long term debt
sustainability?
 Is the country benefiting from a debt relief
programme?
 At what point does the country qualify for debt
relief?
 What have been the patterns (level, nature –
project vs programme-, origin, predictability) of
aid and what can it be like in the foreseeable
future?
 External Support

 External budget support subject to volatility

 Debt relief – a one time measure – cannot be
relied upon for long term planning
 Aid mainly as a gap filling measure - can lead to
enhanced investments in human development
 ODA estimates by Millennium Project – 135
billion USD in 2006 rising to 195 billion USD in
2015
 Requires doubling of ODA but within agreed limit
of 0.7% of GDP
 Challenges and Issues

 How to garner political will for enhanced

resource mobilisation?
 Surge in Commodity Prices – Challenge
and an opportunity
 How to build national consensus on pro-
poor spending?
 How to increase efficiency of expenditure?
 Fiscal Decentralisation – can it be a
solution? – Evidence is mixed
 References
 Chu, Ke-Young, Hamid Davoodi and Sanjeev Gupta, 2000, ‘Income
Distribution and Tax and Government Social Spending Policies in
Developing Countries’, IMF Working Paper, WP/00/62

 Fan, S., and Neetha Rao, 2003, ‘Public Spending in Developing

Countries: Trends, Determination and Impact’, International Food
Policy Research Institute, Discussion Paper No. 99

 Jha, R., 2007, Fiscal Policy in Developing Countries: A Synoptic View,

ASARC Working Paper 2007/01

 Roy, Rathin, Antoine Heuty and Emmanuel Letouze, 2006, ‘Fiscal

Space for Public Investment: A Human Development Approach’, Paper
prepared for G-24 meeting

 UNDP, 2007, ‘Fiscal Space for MDGs’

http://www.undp.org/poverty/e-discussions/fiscalspace/docs/Primer%
20Fiscal%20Space_06-03%20UG.doc