Public Expenditure in Latin Public Expenditure in Latin America: Trends and Key Policy America: Trends and Key Policy

IssuesIssues

Benedict ClementsBenedict Clements

Western Hemisphere DepartmentWestern Hemisphere Department

International Monetary Fund*International Monetary Fund*

ECLAC Fiscal Policy SeminarECLAC Fiscal Policy Seminar

Santiago de ChileSantiago de Chile

January 29, 2007January 29, 2007

* The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

22

OutlineOutline

Latin American Public Spending: A Latin American Public Spending: A Discontinuous March Upward Discontinuous March Upward

Key Expenditure Issues for the RegionKey Expenditure Issues for the Region The Reform Agenda: Making Government The Reform Agenda: Making Government

Expenditure More Efficient and EquitableExpenditure More Efficient and Equitable

33

OutlineOutline

Latin American Public Spending: A Latin American Public Spending: A Discontinuous March Upward Discontinuous March Upward

Key Expenditure Issues for the RegionKey Expenditure Issues for the Region The Reform Agenda: Making Government The Reform Agenda: Making Government

Expenditure More Efficient and Equitable Expenditure More Efficient and Equitable

44

Fiscal balances have improved Fiscal balances have improved in the region in recent yearsin the region in recent years

Latin America: Fiscal Trends(In percent of GDP)

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

20

22

24

26

28

30

Primary Balances (LHS)

Primary Expenditures (RHS)

Revenues (RHS)

Trends in Public Spending

55

Primary spending, however, Primary spending, however, has resumed its upward drifthas resumed its upward drift

Latin America: Primary Public Spending by Region (In percent of GDP)

15

18

21

24

27

30

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Latin American Average

South America & Mexico

Central America

Trends in Public Spending

66

Real spending has followed Real spending has followed a procyclical patterna procyclical pattern

Latin America: Real GDP, Revenues, and Primary Spending

(Annual percent change)

-2

0

2

4

6

8

10

12

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Real Revenues

Real Primary Expenditures

Real GDP

Trends in Public Spending

77

Current spending has driven Current spending has driven the rise in outlays...the rise in outlays...

Latin America: Public Sector Expenditures(In percent of GDP)

16

17

18

19

20

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

4.5

5.0

5.5

6.0

6.5

Current Primary Expenditures (LHS)

Capital Expenditures (RHS)

Trends in Public Spending

88

……while capital spending has while capital spending has fallen as a share of outlaysfallen as a share of outlays

Latin America: Average Public Sector Capital Spending

(In percent of primary expenditures)

0

5

10

15

20

25

30

35

40

LA Average South America and Mexico Central America

1995-1999

2000-2006

Trends in Public Spending

99

OutlineOutline

Latin American Public Spending: A Latin American Public Spending: A Discontinuous March Upward Discontinuous March Upward

Key Expenditure Issues for the RegionKey Expenditure Issues for the Region Cyclicality of spendingCyclicality of spending Public investmentPublic investment Public employmentPublic employment Social spendingSocial spending

The Reform Agenda: Making Government The Reform Agenda: Making Government Expenditure More Efficient and EquitableExpenditure More Efficient and Equitable

1010

Expenditure is procyclical in all Expenditure is procyclical in all spending categoriesspending categories

Capital outlays Capital outlays are the most are the most procyclicalprocyclical

Compared to Compared to other developing other developing countries, a countries, a higher share of higher share of LA countries LA countries have procyclical have procyclical spendingspending

LA countries also LA countries also have somewhat have somewhat higher higher coefficientscoefficients

Cyclicality of Spending

Total Total

SpendingSpending

Primary Primary SpendingSpending

Current Current SpendingSpending

Wages Wages and and SalariesSalaries

Capital Capital SpendingSpending

Latin Latin AmericaAmerica

1.571.57 1.791.79 1.221.22 1.521.52 5.915.91

Share of Latin Share of Latin American American countries with countries with sig. coeff.sig. coeff.

46.246.2 66.766.7 33.333.3 46.246.2 69.169.1

Share sig. for Share sig. for 35 other dev. 35 other dev. countriescountries

31.331.3 40.040.0 40.040.0 28.128.1 45.245.2

Avg. coeff. for Avg. coeff. for 35 other dev. 35 other dev. countriescountries

1.181.18 1.751.75 1.031.03 1.201.20 1.381.38

Estimates of the Short-Run Response of Spending to Output Shocks

Source: Akitoby and others (2006).

1111

There is no evidence of asymmetryThere is no evidence of asymmetry

  

Cyclicality of Spending

System GMM System GMM regressionsregressions

Lagged dependent Lagged dependent variablevariable

0.440.44

(3.06)***(3.06)***

0.490.49

(3.50)***(3.50)***

Output gapOutput gap 0.080.08

(2.30)***(2.30)***

Output gap (when Output gap (when positive)positive)

-0.08-0.08

(0.72)(0.72)

Output gap (when Output gap (when negative)negative)

0.170.17

(1.78)*(1.78)*

Log terms of tradeLog terms of trade 0.030.03

(0.01)(0.01)

-0.25-0.25

(0.09)(0.09)

Response of Expenditure to Output GapsDependent Variable: Primary expenditure to GDP

Output gap has a Output gap has a statistically statistically significant impact on significant impact on spendingspending

Positive and Positive and negative output negative output gaps have different gaps have different coefficients, but the coefficients, but the difference is not difference is not statistically statistically significantsignificant

* Significant at 10%; ** significant at 5%; *** significant at 1%.

1212

Public investment is lower Public investment is lower than in other developing regionsthan in other developing regions

  

Public Investment

1990 – 941990 – 94 1995 – 991995 – 99 2000 – 042000 – 04 2005 – 062005 – 06

Latin AmericaLatin America 4.74.7 4.94.9 4.34.3 4.54.5

AfricaAfrica 7.97.9 7.77.7 7.67.6 8.28.2

AsiaAsia 9.19.1 8.78.7 8.18.1 8.48.4

Central and Eastern Central and Eastern EuropeEurope

3.63.6 3.83.8 3.83.8 3.83.8

Public Investment in Latin America and Other Regions, 1990 – 2006

1313

Not all countries in the region, however, Not all countries in the region, however, suffer infrastructure “lags” suffer infrastructure “lags”

Public Investment

Latin America: Infrastructural Performance ― Deviation of Actual Indices from Values Predicted by PPP-adjusted Per Capita Income

(In percent of the average standard deviation of the residuals)

Panama

El Salvador

Chile

Guatemala

Uruguay

Honduras

Brazil

Colombia

Mexico

Costa Rica

Ecuador

Venezuela

Peru

Nicaragua

Argentina

Bolivia

Paraguay

-200 -150 -100 -50 0 50 100 150 200

Infrastructure

1414

Infrastructure lags may also reflect Infrastructure lags may also reflect inefficiencies in public investmentinefficiencies in public investment

Efficiency can be assessed by evaluating the link Efficiency can be assessed by evaluating the link between public investment and improvements in between public investment and improvements in infrastructureinfrastructure

First step is to evaluate relationship between total First step is to evaluate relationship between total infrastructure spending (public and private) and infrastructure spending (public and private) and improvements in infrastructure using a improvements in infrastructure using a nonparametric techniquenonparametric technique

Public Investment

1515

Infrastructure Infrastructure Production Possibility FrontierProduction Possibility Frontier

Input

(infrastructure spending to GDP)

Ou

tpu

t

(impr

ovem

ents

in

infr

astr

uctu

re

indi

cato

rs)

Y(A)

Y(B)

Public Investment

X(A) X(B)

A

B

C

D

b’

b

Efficient

Less Efficient

The most efficient countries are those on the “production The most efficient countries are those on the “production frontier” (ACD)frontier” (ACD)

1616

Efficiency varies by countryEfficiency varies by countryPublic Investment

Adjusted Public Adjusted Public Efficiency 1/ 2/Efficiency 1/ 2/

Adjusted Adjusted RankRank

Adjusted Level Adjusted Level of Public of Public EfficiencyEfficiency

MexicoMexico 0.8240.824 11 HighHigh

ChileChile 0.7320.732 22 HighHigh

PeruPeru 0.5980.598 33 MediumMedium

ArgentinaArgentina 0.5300.530 44 MediumMedium

BrazilBrazil 0.4320.432 55 MediumMedium

ColombiaColombia 0.2530.253 66 LowLow

BoliviaBolivia 0.0360.036 77 LowLow

Aggregated Public Efficiency Scores

1/ Efficiency in various sectors (transport, electricity, water, telecommunications) aggregated using the share of public investment in each applicable sector.

2/ Adjusted by the effect of private sector spending on the efficiency score in each sector.

1717

Public wage expenditure and employment Public wage expenditure and employment are not high by world standards…are not high by world standards…

Public Sector Employment

Wages, Wages, as a as a percent of percent of

GDPGDP

General government General government employment employment as as percent of total percent of total

employed, 1990semployed, 1990s

Latin AmericaLatin America 7.07.0 20.420.4

AsiaAsia 5.75.7 17.217.2

Eastern Europe and Eastern Europe and Central AsiaCentral Asia

7.97.9 42.342.3

Middle East and North Middle East and North AfricaAfrica

10.610.6 50.350.3

Sub-Saharan AfricaSub-Saharan Africa 9.69.6 28.428.4

OECDOECD 12.112.1 21.021.0

Government Wages and Employment in Latin America and Other Regions, 2004 or latest year

1818

……but the quality of government services but the quality of government services remains lowremains low

Public Sector Employment

20

30

40

50

60

70

80

1996 1998 2000 2002 2003 2004 2005

Latin America

Asia

Eastern Europe & Baltics

Subsaharan Africa

Government Effectiveness(In percentile rank, 1996-2005)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1990 1992 1994 1996 1998 2000 2002 2004

Latin AmericaAsiaEastern Europe & Baltics Subsaharan Africa

The Quality of the Bureaucracy(ICRG Index, 1990-2005)

1919

Wide variance in wage bills and Wide variance in wage bills and quality of civil servicequality of civil service

No relationship between wage bill and quality of No relationship between wage bill and quality of civil servicecivil service

Institutional weaknesses remain in many Institutional weaknesses remain in many countries (IADB, 2005 and Echerbarría and countries (IADB, 2005 and Echerbarría and Cortázar, 2005):Cortázar, 2005): Patronage in hiring and promotionsPatronage in hiring and promotions Absence of performance evaluationAbsence of performance evaluation Internal inequities in remunerationInternal inequities in remuneration

Public Sector Employment

2020

Social spending absorbs a high share of Social spending absorbs a high share of government outlaysgovernment outlays

Health and education Health and education spending in line with spending in line with other regionsother regions

Social protection Social protection

spending lower than spending lower than OECD but higher OECD but higher than emerging Asiathan emerging Asia

Inefficiencies in Inefficiencies in

spending have spending have retarded gains in retarded gains in social indicators social indicators

Poverty remains high Poverty remains high despite substantial despite substantial social spending social spending

Social Spending

EducationEducation HealthHealth Social Social protectionprotection

Total Total 1/1/

Latin Latin AmericaAmerica

4.24.2 2.62.6 5.45.4 12.712.7

Emerging AsiaEmerging Asia 3.53.5 1.31.3 2.22.2 8.48.4

Eastern Europe Eastern Europe and Central Asiaand Central Asia

4.84.8 4.44.4 12.112.1 22.822.8

Middle East and Middle East and North AfricaNorth Africa

4.24.2 2.02.0 1.81.8 9.19.1

Sub-Saharan Sub-Saharan AfricaAfrica

5.55.5 2.92.9 3.73.7 13.813.8

OECDOECD 6.46.4 6.96.9 17.317.3 32.632.6

General Government Social Spending in Latin America and Other Regions, 2004

1/ Total includes housing and community amenities.

2121

The distributive effects of  The distributive effects of  social spending variessocial spending varies

Social spending in Latin Social spending in Latin America is regressive – America is regressive – poorest 20% receive poorest 20% receive less than a fifth of the less than a fifth of the benefitsbenefits

Tertiary education and Tertiary education and social security spending social security spending largely benefit high-largely benefit high-income groupsincome groups

Primary education and Primary education and social assistance social assistance spending primarily spending primarily benefit the poorbenefit the poor

Social Spending

Poorest Poorest QuintileQuintile

Richest Richest QuintileQuintile

EducationEducation 20.220.2 20.420.4

PrimaryPrimary 29.029.0 7.97.9

SecondarySecondary 13.213.2 18.318.3

TertiaryTertiary 1.91.9 52.152.1

HealthHealth 20.620.6 52.152.1

Social securitySocial security 5.65.6 17.617.6

Total social spendingTotal social spending 15.015.0 30.430.4

Shares of quintile in Shares of quintile in primary incomeprimary income

3.63.6 56.456.4

Latin America: Distribution of Benefits from Social Spending to the Top and

Bottom Quintiles

Source: ECLAC

2222

The success of targeted social The success of targeted social assistance programsassistance programs

Conditional cash transfer programs have Conditional cash transfer programs have expanded in recent yearsexpanded in recent years

Benefits have been well-targeted to the Benefits have been well-targeted to the poor and have helped reduce poverty poor and have helped reduce poverty ratesrates

However, these programs remain modest However, these programs remain modest in size (1 to 1 ½ % of GDP) and are a in size (1 to 1 ½ % of GDP) and are a small share of social spendingsmall share of social spending

Social Spending

2323

OutlineOutline

Latin American Public Spending: A Latin American Public Spending: A Discontinuous March Upward Discontinuous March Upward

Key Expenditure Issues for the RegionKey Expenditure Issues for the Region The Reform Agenda: Making Government The Reform Agenda: Making Government

Expenditure More Efficient and EquitableExpenditure More Efficient and Equitable

2424

Taming cyclicalityTaming cyclicality

Reducing spending growth during current Reducing spending growth during current cyclical upswing a key challenge cyclical upswing a key challenge

Fiscal rules to reduce spending growth could be Fiscal rules to reduce spending growth could be helpful -- but need to be backed by effective helpful -- but need to be backed by effective enforcementenforcement

Reducing spending volatility will help improve Reducing spending volatility will help improve

the efficiency of spending the efficiency of spending

2525

Making government spending Making government spending more efficientmore efficient

Infrastructure lags reflect inefficiencies in public Infrastructure lags reflect inefficiencies in public investment investment Large efficiency gains possible by adopting best Large efficiency gains possible by adopting best

practices of most efficient countriespractices of most efficient countries

Quality of civil service varies widely Quality of civil service varies widely Reform efforts to tackle institutional weaknessesReform efforts to tackle institutional weaknesses

2626

Improving the equity of spendingImproving the equity of spending

Continued reform of social insurance schemesContinued reform of social insurance schemes

Make education spending more pro-poorMake education spending more pro-poor Increase user fees in tertiary education, combined Increase user fees in tertiary education, combined

with scholarships for low-income householdswith scholarships for low-income households

Improve quality of secondary education to reduce Improve quality of secondary education to reduce repetition rates and broaden access to tertiary levelrepetition rates and broaden access to tertiary level

Expand targeted social assistance programsExpand targeted social assistance programs